Interview: Thomas Stridsman – Money Management Is Keytradersonline-mag.com/01_ezine/01_traders/en/11/E_Tra12_web.pdf · TRADERS´ magazine. Further TRADERS´ editions will follow

December 2010

Interview: Thomas Stridsman – Money Management Is Key

This Is How You Use

Seasonalities Correctly

The Power of the Calendar

»» Caution: Slippage and Expenses

Better Triple-check the Details

»» Price and Volume Sensibly Combined

All Key Information at a Glance

»» A New Take on Forex Trading 20 Pips a Day Is All You Need

2

12/2010 www.tradersonline-mag.com

TRADERS´ EDITORIAL

This headline will probably remind you of the second part of “Wall Street”, now running in many cinemas. Actually, I wanted to talk about something else but I just need to say a thing or two about that fi lm fi rst. The dilemma posed by a sequel to a classic like “Wall Street” is the incredibly high expectations that precede such a fi lm. Overall, Part Two deserves the rating “not bad” (although a happy ending is not exactly what you would associate with Gordon Gecko). And yet, ultimately many cinema goers were disappointed because it was just like the way it is at a stock exchange when a fantastic record quarter is anticipated and the company then announces “only” a record quarter – people had simply expected “more”. On the stock market, it’s all about more profi t, in the fi lm industry it’s all about more entertainment.

Now let’s turn to the original idea behind the headline. After all, it’s not just in this fi lm that money never sleeps. Anybody who has ever traded a share knows this from his own experience. Every tick, every simple fi ve-minute chart, every candle, no matter which shape, involves the transfer of money – but above all, trading with hopes and expectations, which may well be the most important factor in that “money never sleeps” equation. Because what happens on the stock market is that it is precisely because of the implicit hopes and expectations that the future is being traded, which makes the fi nancial markets one of the best leading indicators for the economy as a whole. And the brilliant thing about that is that the powerful signifi cance of price developments on the stock markets is achieved by simply bringing together supply and demand! This resembles an ant heap where each ant running

hither and thither only has a fraction of all the information, but the logistics of the overall effort are nonetheless organised perfectly. No single individual could ever coordinate the prices of innumerable securities, using a (more or less exact) unit of value equally as well as the mass of all market participants can. It is for precisely this reason that there is and always will be no alternative to the stock exchange. Or do you know of a more effi cient price-fi nding mechanism?

Good Trading,

Lothar Albert

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TRADERS´ CONTENT

12/2010 December

COVERSTORYHow You Use Seasonalities Correctly

39 STRATEGIES20 Pips a Day Is All You Need 53 PEOPLE

Thomas Stridsman

16 INSIGHTSCaution: Slippage and Expenses 50 BASICS

Perceived Value Vs. Real Value

COVERSTORY

This Is How You Use Seasonalities Correctly

Our underlying theory is that future market behaviour will be similar to that of the past, which allows methods to be developed with regard to time and calendar-based market conditions. As a result, the cycle and calendar theory may well usefully complement existing trading strategies.

INSIGHTS

Caution: Slippage and Expenses What You Need To Remember Prior To Using Your Trading System

Trading on Sports Exchanges For Traders, Not Gamblers

TOOLS

New Products

Bookmark

Softwarereview

Webreview

BASICS

A Guide to Picking Stock Market Winners – Part 1Trading Dead Cat Bounces

Perceived Value Versus Real Value Trust Only the Market Itself

PEOPLE

Thomas StridsmanThomas Stridsman is well known as a designer of trading systems. He has many years of experience in the industry. Today, Thomas is working at Alfakraft Fonder where he manages two funds as head portfolio manager. We are happy to talk to Thomas about his ideas and trading tactics. The main conclusion is that Money Management is really key to the trading business. Be prepared for an insightful interview.

STRATEGIES

Better Trading with Candlevolume Charts – Part 1

Price and Volume Sensibly Combined

20 Pips a Day Is All You Need A Simple Way of Trading

The Retracement at the Open Trading those Big Gaps

5


TRADERS´ INFO

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PhoneFax

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Subscription Service

Address of Editorial and Advertising Department

Editor-in-Chief

Editors

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Price data

ISSN

Disclosure

TRADERS´ media GmbHBarbarastrasse 31, D-97074 Wuerzburg+49 (0) 9 31 4 52 26-0+49 (0) 9 31 4 52 [email protected]

Lothar Albert

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Lothar Albert

Prof. Dr. Guenther Dahlmann-Resing, Karsten Gore, Johann Gorol, Marko Graenitz, Theresa Hussenoeder, Sandra Kahle, Christian Krauß, Nadine von Malek, Rodman Moore, Astrid Mueller, Stefan Rauch, Tina Wagemann, Sarina Wiederer

Clem Chambers, Chuck Fulkerson, Philipp Kahler, Mathias Kufner, Ryan Like, Christian Lukas, Eric Waddell, Peter Webb

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The information in TRADERS´ is intended for educational purposes only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Trading and investing carry a high level of risk. Past performance does not guarantee future results.

MASTHEAD

TRADERS’ media GmbH is a fi nancial markets publisher specialicing in education and further education in the fi eld of trading and stock markets. TRADERS’ media was founded in April 2004. It publishes the trading magazine TRADERS´ in the German (print), English (digital), and Dutch (digital) languages every month. TRADERS´ magazine was founded in 2001 by market mavericks Lothar Albert and Allison Ellis. Lothar Albert is CEO of TRADERS´ media GmbH and chief editor of TRADERS´ magazine. Further TRADERS´ editions will follow focusing on Asia (Singapore), India and Russia and coming soon in the very near future, an edition for Latin America in Spanish. For four years in a row, 2004-2007, TRADERS´ has been awarded the title of World’s Best Magazine for Traders by Trade2Win, an international community of traders.

TRADERS´ is different and unique because we do not give any advice or recommendations on what to trade. This makes our content very different from any other market magazines. We are not interested in giving people certain buy and sell recommendations, but rather in teaching the basics of trading from the state of the beginning to the professional level.

Our magazine has established itself as a source for information and communication for elite traders in Germany, Europe and around the world. Current information about technical, mathematical and psychological aspects of the markets is discussed in professional articles and interviews. Each issue contains articles about trading strategies (for basic, intermediate, and advanced traders), risk management, technology for traders, business issues for traders, book and website reviews, and much more!

Still today, the trader-elite are interested in professional and current trading knowledge and experience. For dedicated traders, there is no need for buy and sell recommendations. Trading pros make their decisions with self-confi dence and are self-contained. These people know that trading can be profi table in bull and bear markets. The question is: what are the markets and tools that lead to success? TRADERS´ magazine addresses this question every month in both the German and English languages.

Automated Trading Championship

The TRADERS´ magazine is a long-term media sponsor of the Automated Trading Championship – also in 2010. After the previous Championships, the magazine has published a number of materials devoted to technical analysis. Methods of technical analysis are widely used in the development of Expert Advisors – programs that trade without human interference.

confi dence and are self-contained. These people know that trading can be profi table in bull and bear markets. The question is: what are the markets and tools that lead to success? TRADERS´ magazine addresses this question every month in both the German and English languages.

Statistical Evaluation of Various Calendar Effects

This Is How You Use Seasonalities CorrectlyMarket fluctuations are subject to certain patterns with regard to price and time. Our underlying theory is that future market behaviour will be similar to that of the past, which allows methods to be developed with regard to time and calendar-based market conditions. The resulting conclusions may then be used as indicators capable of helping you to better assess future price behaviour. This causes your trading setups to be more likely to succeed and raises your chances of higher profits. As a result, the cycle and calendar theory may well usefully complement existing trading strategies.

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TRADERS´ COVERSTORYTRADERS´ COVERSTORY

Cycles in Different Time WindowsDepending on the market, highly meaningful evaluations of a market’s movement of direction can be made on the basis of weekdays, certain trading days, or a month. For instance, raw materials, especially metals and soft commodities have been relatively bullish in the last few years, particularly on Wednesdays and Thursdays, and as far as crude oil is concerned, Friday has turned out to be the clearly strongest trading day of the week.

Even in Intraday trading, a market may develop certain characteristics. For example, Monday, Tuesday, and Thursday may register a minor sell-off on the Dow Jones in the fi rst 30 minutes. With the last few years having only seen a 46 per cent probability of rising prices. In complete contrast to this, throughout the entire week the fi nal trading hour saw the market rise at an average rate of 54.4. per cent – and do so with a high degree of probability. Regardless of whether it is day, swing, position or buy-and-hold trading, if you know the numbers of the traded underlying, you will already be ahead of many other participants.

The Best and the Worst Months“Sell in May”, or “October is the most hazardous month on the stock exchange” are common adages in the trading world. But are there really periods of time within a year that are better suited for investments in a certain underlying than others? The answer is “Yes.” If you look at the performance of a certain month from the fi rst to the last price, add up these fi gures and fi nally divide them by the number of months studied, you will arrive at a corresponding performance ratio. Depending on the market, there may be major differences between the individual months. For example, on a monthly basis the S&P 500 was more bought than sold in 45 out of 60 Decembers, whereas in September not even half of the months investigated closed in positive territory despite a general upward tendency from 1950 to 2009 (Figure 1 and Table 1). The results are similar as far as the Dow Jones, the Nasdaq or the German market is concerned.

Within a month’s period, as well, an investigation of price action provides important insights. When you compare the closing prices of a day to those of the previous day on a percentage basis, you measure the dynamics

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F1) S&P 500 from 1950 to 2009 by months

In Figure 1 you can see the monthly performance and the average price changes in the S&P 500. Towards the end and the beginning of a year the biggest price gains are made with the summer months being relatively weak.

Source: TRADERS´ graphic

T1) S&P 500 from 1950 to 2009

*Share of positive months in percentage terms; ** average performance in percentage terms. Table 1 shows the monthly performance and the average price changes in the S&P 500 from 1950 to 2009.

Month Hit ratio* Performance on average **

January 60 0.89

February 52.5 -0.29

March 65 0.93

April 68.3 1.32

May 58.3 0.43

June 51.7 -0.02

July 53.3 0.72

August 56.7 0.13

September 44.1 -0.51

October 58.3 0.41

November 66.7 1.26

December 75 1.32

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TRADERS´ COVERSTORY

of price movements within a particular trading month. At this point we can now introduce further subdivisions. Moreover, we can carry out an evaluation in which the closing price of a day and that of the previous day are compared to one another within a period of one month. This day-to-day performance can be meaningfully combined with the indicator of the trading day of the week or that of the trading day of the month, and in a historically bullish market it can support long positions or prefer short entries in a fragile environment. There is also the equally good possibility of combining the

indicator with extended criteria, which may, for example, result from fundamental analysis, company news, quarterly fi gures etc. Individual stocks and the correspondingly large selection offer the greatest chances of success on account of the numerous variations possible. After all, this is all about “loading the dice”, i.e. having the probabilities of high hit rates and maximum profi ts play out in one’s favour. Price-based seasonality is very helpful here.

Qualifi cation Added: Extreme SituationsAs you know, fi nancial markets

sometimes – but with alarming regularity – experience major upheavals. When signifi cant news and volatility come in thick and fast, seasonality has no relevance for the short or medium term. Examples of these in the more recent past include the onset of bear markets after the bursting of the dot.com bubble, after the terrorist attacks of September 11, after the Lehman Brothers’ bankruptcy, and after the banks’ need for depreciation in the wake of the fi nancial crisis. In such situations marked by extreme volatility, a day-of-the-week or day-of-the-month fi lter should not be used.

The First Week of the Year At the beginning of a year, major players like asset management companies, banks or hedge funds want to or need to enter the market in order to be able to meet investment quotas or performance goals. On the very fi rst trading day of the years 1998 to 2010, the S&P 500 performed at an average of +0.19 per cent, with many European indices performing markedly better. The tendency towards a rising market with extraordinary capital infl ow is also shown by the evaluation of the S&P in the fi rst week of the years between 1950 and 2010. In 38 of 61 cases (=62.3 per cent)

the Index was in positive territory after Week 1. In cases where some selling did take place, then this sometimes happened quite noticably by up to fi ve per cent on a weekly basis. On average, a negative fi rst trading week lost 2.1 per cent in the broad-based S&P. Weeks exhibiting price gains performed at an average rate of +1.7 per cent.

Calendar Theory Part II: January“As goes January, so goes the year.” “Once I know how January went, I can predict developments for the whole year.” While such a statement might be considered

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to be naïve or even provocative, it is actually highly likely to be correct. If the market tends to fall in January, then the entire year will certainly close with losses, too, and vice versa. In the last 60 years this January indicator has turned out to be correct in 47 years as regards the S&P 500, which represents 78.3 per cent of the years. Even more interesting is the next number: In 42 of the 60 years, the Index closed higher in the direction of movement at the end of a year than the January closing price whenever the latter had gone up, and even lower than an already bearish January. The hit rate of such a strategy is precisely 70 per cent based on statistical records from 1950 to 2009.

The Typical DecemberHistorically, December stands for a relatively strong performance. Between 1991 and 2009 this month was a positive-territory month in 13 out of 19 cases with performance ranging from -6.2 per cent to +9.5 per cent with a corresponding expected value of +1.62.

Christmas Mood on the FloorThe public holidays around Christmas and New Year’s usually mean rising prices. The last six trading days before the end of the year were investigated in the S&P 500. It is possible that it is the lack of price-impacting news or

a generally stock-friendly mood that caused the Index to tend markedly upwards in the fi nal days of the year with especially the days around Christmas being real price drivers. The root cause can probably be found in the investment behaviour of funds that either do some real shopping in preparation for the upcoming year, or make purchases as part of some window dressing to embellish their balance sheets with a view to suggesting to potential new customers that they have given proof of having the right feel for certain markets or individual shares. After all, it is especially in the upward-moving stock markets that the tendency towards further price hikes is becoming more pronounced in the fi nal years of the year; historically, the last trading days of a year have been absolutely bullish, as is shown in Overview Figure 2.

Reasons for Price-based SeasonalityPortfolio adjustments and regroupings are of a particularly major nature at the beginning or end of a month or year. During these time periods investors seem to be inclined to rethink existing positions and make new commitments. Other predictable factors infl uencing prices include expiry dates and presidential elections as well as bank and

annual holidays for traders and investors. What is important to know is what the market has done in the past and what it will, in all probability be doing under “normal conditions”. If price movements often historically behaved similarly, there are good chances of market behaviour repeating itself. With some planning and backtesting, the “optimal” time windows for short, medium and long-term trading can be determined. This is something you can bet on. Depending on the market, cycles of a short, medium or long-term nature may appear and be evaluated. Moreover, it all depends on whether day, swing or position trading is given preference.

Presidential ElectionThere are some empirical studies revealing the connections between politics and the markets. What all these results have shown can be summarised by saying that in an election year the markets almost always rise and that the Index performance in the US clearly does better under a Democratic administration than a Republican one.

Obviously, further investigation needs to be conducted. A a quick example: In an election year both the administration in power and the opposition like to present themselves in the

T2) Typical December

*in percentage terms; Table 2 shows the statistical evaluation data from Figure 2.

6 5 4 3 2 1

Average 1969-2004

0.09 0.33 0.34 0.12 0.19 0.06

2005 0.41 -0.25 -1.09 -0.08 -0.48 -0.57

2006 -0.38 -0.41 -0.69 0.56 -0.2 -0.42

2007 0.73 1.12 0.69 -1.37 -0.55 -0.82

2008 -1.84 -1.2 0.6 -0.09 2.07 0.46

2009 0.87 0.56 0.12 -0.13 0.13 -0.02

Average 1969-2009

0.074 0.286 0.29 0.078 0.19 0.019

F2) Typical December

Figure 2 shows the statistical evaluation of the last six trading days in December for the S&P 500 between 1969 and 2009.


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T3) Midterm Year

* in percentage terms; here you can see the results of the midterm year and the performance of the respective third quarters since 1954.

or America was at war. These events are basically critical for the economy, for companies and their profi ts. If the country is in an economically fragile cycle, this obviously does not necessarily mean falling prices. A good example from the more recent past is the beginning of the bull market in March 2009, which occurred in the midst of the recession that had been caused by the fi nancial crisis.

Midterm YearWhat happened on the stock market in the second year after the presidential election? And – related to the above mentioned evaluation of the performance on a monthly basis – what can be expected in the coming months? Table 3 shows the results of the midterm year as well as the performance of the respective third quarters since 1954. There were eight positive annual results as opposed to six negative ones, ranging from -27.6 to +44 per cent, which translates into an annual average yield of slightly more than six per cent and is just mediocre. Summer months from June to September usually perform in line with the market in bull markets, but partially reinforce the downward markets massively, as they did in 1966, 1974, 1990, 1998 and 2002. The average yield in the third quarter is also negative.

Fundamentals – CommoditiesThere are usually cogent reasons for seasonality and its attendant price cycles in commodities. The fundamental force behind price movements for commodities, for example, which primarily serve industrial manufacturing, is the profi t that producers and consumers of commodities expect to make. If prices are low and there is little or no profi tability, some producers will get out of the business for some foreseeable time, lessening demand. But this also means that there will only be little or no investment at all and this usually does not occur until a seasonal or business cycle comes to an end and a change in trend has begun. For example, there is a sell-off of timber in summer with a low in October since, with winter around the corner, new-home orders will decline. An acceleration in demand will not materialise until winter with the attendant recovery of new construction in spring.

The weather and the cycle of planting and harvesting also play an important role. For example, prices, as a rule, reach their lows in June and July respectively and their highs in winter. However, since this is generally known, such developments are already priced in on the futures exchanges. For instance, the price of a December contract is higher than that of a June

brightest light possible before the electorate. There seem to be hardly any limits to the variety and imagination in the many promises made to companies and the populace. The overriding aim usually is “Peace and Prosperity for Everyone”. Of course, among other things, the economy should be booming and everything will be set in motion to meet this goal. After all, this is designed to impress the electorate ahead of time in order to prepare it for less popular decisions that may well lie ahead. Once the election is won, it is usually followed by a more or less short period of enthusiasm, drive and resoluteness before the less pleasant intentions of the government are fi nally implemented.

Although during the Clinton years in the nineties or during Bush’s second term of offi ce from 2005 on, the years after their (re)-election saw neither a war nor a recession, but there have been examples of post-election years having a devastating effect on society and the stock markets. Examples include 2001 (9/11, dot.com bubble), 2009 (fi nancial crisis, recession), 1965 (Vietnam war under Johnson) or 1941 (Roosevelt during World War II). In 20 of the 25 post-election years investigated since 1913, the American stock market was either in a recession or crisis

Year Quarter 3 Annual performance1954 8.1 44.01958 11.3 34.01962 3.2 -10.81966 -11.0 -18.91970 11.3 4.81974 -24.3 -27.61978 5.7 -3.11982 10.4 19.61986 -6.6 22.61990 -14.9 -4.31994 6.0 2.11998 -12.4 16.12002 -17.9 -16.82006 4.7 16.32010 23.58 ?

On average -1.89 5.57

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contract. Such a seasonal cycle can be used effectively on the spot markets.

November and December see price peaks in heating oil since pipelines operate at maximum capacity in those months in order to prepare for high consumption in the winter months. And gold and silver tend towards highs at the end of the fi rst or the beginning of the second quarter. The subsequent summer months perform relatively weakly. Similarly to the stock markets, new maximum highs are frequently reached towards the end of the year.

The Problem with the Number of TestsTrades on a statistical basis should always be looked at with a healthy dose of scepticism. Some of the examples given here were only based on a small number of test data. For example, presidential elections are only held every four years, and looking back on the Dow Jones is not possible beyond the year 1918. It would also be possible to examine a two-year bull market by just fi nding a certain day of the week 52 times. Would that be enough data? If an important fundamental accounts for a certain market tendency, “ineffi ciency” may well be resorted to. Of course, the reason must be known in order

to make adjusting to changed market conditions possible should that become necessary. However, with small amounts of data any deviations may be pure coincidence. And even if additional research does not lead to another conclusion, this deviation should actually be completely dismissed or it should at least be possible to draw upon other additional satisfactory criteria for entering a position.

Another danger is that markets may change fundamentally. In the 70s and 80s Mondays were by far the weakest days of the week in American stock indices (on the Nasdaq, for example, the percentage rate of positive trading days was only 41.1) whereas on a weekly basis the share of buyers continued to increase.

ConclusionThere are certainly good opportunities with a high degree of plausibility for traders and investors to use seasonality. For example, the expected duration of a price movement or swing in a market can be measured by using historical data. The resulting values can then be meaningfully integrated into trading decisions. After all, as some of the examples suggest, more often than not, amazingly high degrees of probability can

be deduced. This means that seasonality is another supporting indicator which should be used carefully and in a specifi c environment in order to sense the direction and intensity of a movement as well as possible turns ahead of time and/or to determine the holding period for a position.

All market participants are human beings and they just happen to have a tendency to replicate their own behaviour – for good or ill. Some markets even develop inferences from the trading styles of those who trade in them. Regardless of the time-based theory, factors like support and resistance may dominate although a cycle-dependent high or low may appear. Should the price reach an important support level before the cycle theory suggests a new low, the market is arguably more likely to initiate a counter-movement prior to that. The use of a time-based driving force would be part of an obvious contrast here. Although price movement and cyclical timing do not coincide with suffi cient signifi cance to be used separately, a time-line may support and move the ride in a certain direction for a longer period of time.

Seasonality

Seasonality is a characteristic of a time series in which the data experiences regular and predictable changes which recur every calendar year. Any predictable change or pattern in a time series that recurs or repeats over a one-year period can be said to be seasonal. Seasonal effects are different from cyclical effects, as seasonal cycles are contained within one calendar year, while cyclical effects (such as boosted sales due to low unemployment rates) can span time periods longer or shorter than one calendar year. Seasonality can be seen in many time series, and it is more common than you might think. For example, if you live in a climate with cold winters and warm summers, your home heating costs probably rise in the winter and fall in the summer. You would reasonably expect the seasonality of your heating costs to recur every year. Similarly, a company that sells sunscreen and tanning products would see sales jump in the summer, but drop in the winter.

Source: www.investopedia.com

13


TRADERS´ NEWS

Warren Buffett’s Succession Planning Initiative

In selecting a little-known hedge fund manager, the Berkshire Hathaway investment company founded by Warren Buffett seems to have taken a fi rst step in fi nding a successor to the investing legend. Buffett, who turned 80 in August, has now tapped the 39-year-old Todd Combs as the leading candidate to succeed him as CIO at Berkshire Hathaway. Combs’s Castle Point Capital Management hedge fund manages some 400 million US dollars – “small fry” compared to the approximately 100 billion dollars in Berkshire Hathaway’s investment portfolio. According to the Wall Street Journal, Buffett’s comment on Todd Combs’s new line of work included this qualifi cation: Mr. Combs “will not be taking over all the investment functions as long as I’m in charge of them. I hold this dual position as CEO and CIO, and I will continue in this role.” In a July letter to his shareholders, Combs wrote a sentence that could also have been penned by Warren Buffett: “At Castle Point we like to think of ourselves as the owners of the businesses we invest in.” He went on to write that it was a convincing argument for the reality of failure that 99.9 per cent of biological species that have ever existed are now extinct. It was much the same with the fi nancial markets. The example he cited was that only one original member of the Dow Jones Industrial Index continues to be a member today. It came as no surprise to observers that Buffet took a less travelled road to fi nd a potential successor. The most talented people and the people with the best independent judgment are not to be found at large institutions.

Source: www.boerse-go.de www.reuters.com

International Green Investing Conference 2010

EDHEC, in partnership with Ville de Nice, Nice Côte d’Azur, EPA de la Plaine du Var, Team Côte d’Azur and CCI Nice Côte d’Azur have decided to launch an international conference to promote Green Investing. By organising the Nice Côte d’Azur International Sustainable Development Financing Conference, EDHEC and its partners are seeking to present the latest research on investment criteria in sustainable development and on new fi ndings and innovative projects in the fi eld of green business. The morning of December 10.12.2010 will be broken down into plenary sessions presenting research on the fi nancial assessment of sustainable development investment. These sessions will be followed by a round table discussion on the subject of how to stimulate investment in sustainable development in Europe, with European leaders from the OECD, the European Investment Bank, the French Ministry of Sustainable Development as well as representatives from two major sustainable development funds. The afternoon will be dedicated to workshops where innovative green businesses will share their expertise in terms of clean technologies and will present their vision of the following sectors, future developments and their positioning of new offers and technologies within these sectors. Topics are smart grids and energy storage, green building and energy effi ciency, renewable energy, water treatment and waste management etc. A presentation of the FTSE EDHECRisk Effi cient Eurobloc ERAFP Large Caps Custom SRI index will close the conference. You will fi nd further information and a link for registration at http://www.edhec-risk.com/events/edhec_conferences/Green_Investing_2010.

CME Offers Financial Products for Rain

In future, the Chicago Mercantile Exchange (CME) will be offering options and futures on rain, making climate forecasting an ever bigger and standardised business. According to a report by the “Weather Risk Management Association”, the weather market already is worth 15 billion dollars today. As the world’s largest derivatives market, the CME makes speculating on the future probability of rain possible, adding to the existing range

of weather derivatives, which already include fi nancial products speculating on snowfall, hurricanes, frost, and unusual temperature fl uctuations. Above all, futures and options offer more fl exibility than standardised insurance contracts. The weather-risk hedging business is relatively young with the fi rst weather derivative being traded by Aquila Energy in the US in 1997. Today businesses especially exposed to weather risks are involved in hedging, for

example utilities, concert promoters, and sporting event organisers or theme park operators. But the weather is also key to generating alternative energy. Rain products in Chicago had a somewhat bumpy start. Only a handful of contracts are traded daily. But market-savvy people know that there may well be a “rain bubble” in the future.

Source: www.guardian.co.uk

14


TRADERS´ NEWS

Email Loses UBS Ten Million Dollars

A UBS banker has allegedly lost the bank more than $10m (£6.2m) in fees, after he sent an email detailing General Motor’s (GM) upcoming fl oat to over a 100 of the fi rm’s clients. The alleged leak was disclosed in papers fi led by GM with the US regulator the Securities and Exchange Commission (SEC). GM’s fi ling warned that the email, which contravened SEC rules governing IPOs, meant that investors who bought GM stock could seek refunds or damages because of the leak if UBS had remained an underwriter on the deal. “We had no knowledge of the e-mail until after it was sent, and the e-mail does not refl ect our views,” GM said in the fi ling. UBS, which is led by chief executive Oswald Gruebel, would have earned an estimated $10m in fees in the $13bn share sale.

Source: http://www.cityam.com/news-and-analysis/email-loses-ubs-10m

SEC Discusses Imposing Limits on High-Frequency Traders

According to Ms. Mary Schapiro, the chairwoman of the US Securities and Exchange Commission, the agency is currently considering imposing limits on high-frequency trading. This group of market participants increasingly bets on fast algorithms and continues to be suspected of being responsible for this year’s fl ash crash on 6th May. More stringent monitoring mechanisms are designed to reduce the volatility and instability of the markets that high-speed traders have helped to create. One suggestion is the possibility of requiring a minimum time for traders to keep their orders in the markets, an idea originally proposed by the data service provider Nanex. We can’t wait to hear what the authorities are going to come up with in the end.

Source: www.boerse-go.de

CQG Expands Connectivity to Russian Markets

Do We Have a Coffee Bubble?

Starbucks have made a dent in the price of coffee when it reached a new 13-year-high (once again). The current price of coffee is considered to be “untenable” by the company. In the words of Howard Schultz, their chief executive offi cer, speculators are responsible for coffee’s price rally on the markets. The bearish assessment of the world’s largest coffee shop chain sent prices for Arabic coffee tumbling in New York. However, on the long-term chart this is nothing but a minor pullback so far.

Source: Rowena Mason at www.telegraph.co.uk

CQG enhanced its Russian offering to include spreading of FORTS, the futures and option component of the Russian Trading System Stock Exchange (RTS), and low-latency trade routing to RTS Standard, the equity market for Russian securities. CQG previously offered trade routing and market data for FORTS. The trading connection to RTS Standard is the latest addition to a growing list of exchanges to which CQG provides direct market access. Spread traders now

have the opportunity to easily create, trade, and manage both inter- and intra-exchange spread strategies for FORTS products via the server-side CQG Sprea-der, CQG’s industry-leading, low-latency spreader product. CQG’s hosted trading gateway provides traders with fast and highly cost-effective access to RTS Stan-dard. CQG customers can route orders to the exchange using the CQG Integrated Client and CQG Trader platforms.

Source: www.cqg.com

SGX Launches OTC Clearing

Singapore Exchange (SGX) has successfully launched the new clearing service for over-the-counter (OTC) traded fi nancial derivatives, starting with clearing of interest rate swaps. At launch, nine banks were admitted as SGX Bank Clearing Members for the clearing of OTC traded fi nancial derivatives products. The nine banks are: Barclays Bank PLC, Citibank N.A., DBS Bank Limited, Deutsche Bank AG, The Hongkong and Shanghai Banking Corporation Limited, Oversea Chinese Banking Corporation Limited, The Royal Bank of Scotland plc, Standard Chartered Bank and United

Overseas Bank Limited. Mr. Muthukrishnan Ramaswami, President of SGX, said, “The launch of this new clearing service is a signifi cant milestone for the fi nancial services industry in Singapore”. A fi rst of its kind in Asia, the service provides clearing members with access to SGX’s central counterparty clearing service, reducing counterparty risk and enabling growth in OTC derivatives activities. For more information on the new OTC clearing facilities for fi nancial derivatives, please visit www.sgx.com.

Source: www.futuresmag.com.

What You Need to Remember Prior to Using Your Trading System

Caution: Slippage and ExpensesMy last article (TRADERS´ November 2010) discussed the principal problems encountered when simulating a trading strategy with historical data. The following text will describe how expenses, fees and the selection of the right trading instrument may influence the real-life performance of your trading system.

17


TRADERS´ INSIGHTSTRADERS´ INSIGHTS

F1) The System Basket without Expenses

In real-life trading the underwater phases of the system are also signifi cant. For example, from October 2009 to May 2010 nothing was earned.

Source: www.tradesignalonline.com

Backtest: Everything’s Fine!Before you consider using your trading system in a real-life environment, the backtest needs to be completed fi rst. Never mind at this point how fast this system might make you a millionaire but concentrate on its inherent risk fi rst. Will the maximum historical drawdown be so small that you will not get nervous in the future should it reappear? Look at the underwater phases of the system. These are those phases during which the system does not make fresh money but recoups losses made in the past. Would you be consistent enough to trade the system through such a phase?

How these ideas play out in practice can be pictured by looking at Figure 1 showing the large-range-day system trading volatility breakouts on the intraday chart and described

in my book “Trading Strategies (not) only for Extreme Situations”. The performance refers to the simultaneous trading of one DAX Future, ten Bund Futures, and 500,000 EUR/USD. Slippage-wise, the results include the respective bid-ask spread of the instrument but no fees. The position will be held until the end of the trading session unless there is a countersignal. Is this system suitable for you? Take a look fi rst at the maximum drawdown (red histogram), which amounts to about €35,000. If that is fi ne with you, take a look next at the underwater phases. During these phases, private traders in particular often fail due to their inability to consistently implement the system signals. It is therefore absolutely necessary to determine ahead of time whether you have the nerve for

Philipp Kahler

Philipp Kahler studied Electrical

Engineering and has worked

in fi nance for eight years. After

working as proprietary trader

at Bankgesellschaft Berlin he

now developes and oversees

quantitative portfolios for insti-

tutions. He lives in Graz and

Berlin, and can be contacted at

http://quanttrader.com.

18


TRADERS´ INSIGHTS

this system. It may well take six months for the system to develop a new high for its profi ts. Not until you consider a drawdown of €35,000 and six months without any profi ts to be okay for your trading does it make sense to think about the continued use of this trading system.

Expenses and SlippageOnce you have found a system for which you have the nerve to imagine trading it consistently even during bad phases, you can begin to check the system for its suitability in a real-life market environment. The essential difference between the backtest and the real market is above all that you often cannot trade the prices that the computer gives you as entry or exit prices on the market. Just assume that the trading system wants to buy the DAX Future at 6310. If you look at the order book at that point in time, the price for the DAX Future presumably is at 6311 to 6310. You could buy at 6311 and sell at 6310. In that case you would pay one point more then the computer indicates as an entry price, creating costs amounting to €25. Add to that the expenses required of you by the broker for this trade. Let’s assume those amount to fi ve euros. Now if you are a big trader and trade ten contracts instead of one, you will, lacking liquidity, time and again

be confronted with the problem of, getting only three contracts at 6311, another six at 6312 and the fi nal one at 6313 to stay with this example. This may be the result of a slim order book. So, depending on the size traded, factoring in only one point for slippage is usually not enough.

In Figure 2 you can see what will happen to this approach if you assume every trade results in €100 worth of slippage and expenses. The same system is shown as in Figure 1 except that in this case an additional €100 per trade is deducted. You would certainly be on the side of caution with this estimate but this also quickly reveals the problems occurring in real-life trading, the fi rst of which is that slippage and expenses not only cause the result to be worse at the end of the year – which is what you would expect. But what is far worse is that slippage and expenses cause the drawdown to be larger. In Figure 1 the maximum drawdown appeared in March 2008 and was never exceeded. Slippage and expenses increase the drawdown especially during those phases in which the system has problems anyway – here between October 2009 and May 2010. In this example, the drawdown rose by approx. €15,000 to more than €50,000 with the overall result being reduced by more than

€100,000. In addition, it takes longer for the system to achieve a new profi t high after its top result in October 2009 (about another month).

Expenses and DrawdownThe main reason why expenses and slippage are a poison for each trading system is that they not only worsen the fi nal result but also deepen the drawdown and prolong the underwater phases. This means that a system that is basically good may very soon no longer impress users in real-life trading. How dramatic this impact may be can be seen in Figure 2.

In real-life trading this system basket reacts especially sensitively to expenses since it trades once nearly every day and always closes the position overnight. So in a worst-case scenario, you pay the fees and have to put up with slippage twelve times a day (basket of three underlyings, one long trade and one short trade each possible).

At this point, the following calculation can be made as a rule of thumb: For the system to impress users in the real-life market environment, too, the average trade of the system should be three times as large as the amount factored in for slippage and expenses. In the system shown here as an

F2) System Basket with €100 Expenses per Trade

Figure 2 shows the same system as Figure 1, except that in this case an additional €100 per trade is deducted for slippage and expenses. This increases the drawdown between October 2009 and May 2010 by around €15,000 to more than €50,000, and the overall result is reduced by more than €100,000.


19


TRADERS´ INSIGHTS

example, the average trade is at €345 – at €100 for slippage and expenses the system could just about still be used in the markets mentioned.

The slippage and expenses problem obviously occurs more frequently in intraday models. If your system trades on the weekly chart, you will necessarily be more busy solving the problems related to the right simulation as discussed in the last article than worrying about expenses.

In a way similar to slippage and trading fees, the costs incurred by using commercially available systems also impact performance. For example, if an administrative fee is charged or you need to pay a monthly rental fee for the system, this will also increase the drawdown and prolong the underwater phases. So when using systems that have been bought, make sure that the rental charge is as low as possible.

Many commercially available systems can also be rented with a high-watermark equity fee. In that case you only pay something for the system if it also earns money. In contrast to a fi xed monthly rental charge or an extended bid-ask spread, this has the tremendous advantage of the high-watermark fee neither

increasing the drawdown nor prolonging the underwater phases.

You can see an example of this in Figure 3. Fees charged by commercially available systems basically worsen the performance of your portfolio. If the system

supplier requires a rental fee or if the broker, while making the system available “free of charge”, instead extends the bid-ask spread or raises the fees per trade, this will result in the drawdowns being higher than forecast and the system taking longer to recoup losses incurred in between. However, if the system is billed according to the high-watermark equity fee (HWM), the system supplier will only receive something if the system also shows real profi ts. This billing model has the advantage of neither the drawdowns being increased nor the underwater phases becoming longer. So if you wish to trade commercial systems, you ought to look for those that are billed in accordance with this fee.

You only pay if real profi ts are generated.

Index, Future, CFDLet’s assume that even after evaluating the slippage-and-expenses system, you come to the conclusion that it is suitable

for you. Only the drawdown you would fi nd to be too large at €50,000. You might now consider trading the system with a smaller size. Instead of ten Bund Future contracts you would then trade

only one, instead of the 500,000 EUR/USD you would trade only 50,000, and instead of the one DAX Future you would trade only one CFD. These considerations are correct with regard to Bund Futures and euros. As for the CFD, this is unfortunately not always the case in reality. Time and again a trade is triggered in a future, but not in a CFD. Besides, most CFD brokers tend to lift the bid-ask spread above that of the future during volatile phases. This makes it easier for the brokers to hedge the position running counter to the CFD. However, this approach makes it impossible for you to achieve the future system performance with the CFD. So before you blindly put your trust in the DAX Future CFD running exactly like

F3) System basket with/without Performance Fee

The difference between the two curves is the 10% high-watermark fee. However, you can also recognise that the system is developing with this fee just as it is without any fee.


With the HWM fee, you only pay if real profi ts

are generated.

20


TRADERS´ INSIGHTS

the future itself, you should rather test the trading system with the historical data of the CFD. Take into account, too, that the CFD presumably generates more slippage than the future. In most cases, implementing a system written for a future by using CFD‘s is not worth it in the long run. The reason for that is the micro discrepancies between future and CFD. However, the difference between future, index and CFD must be kept in mind not only in high-frequency trading systems but also in longer-term-acting trend-following systems (see Figures 4 and 5).

Since the data history of the DAX index is considerably longer than the history of the DAX Future, many traders are tempted to test their trading system with the data of the index. In principle, this would certainly make sense since in a test a longer history, as a rule, also means that the results are more reliable. However, those who think that the DAX Future and the DAX index are so similar to one another that this approach could be justifi ed, are mistaken. In Figure 4 you can see the swing-point system (SPS) from my book fi rst with the DAX index data. It is a trend-following model oriented towards the longer term which refl ects the major trends, but does not trade meaninglessly to and for in weak-trend phases. It uses the local highs and lows in

order to recognise the direction of the trend and to go long during new highs or short during new lows. With each trade, the position size is adjusted in such a way that the same risk is being run invariably. The system was able to use the strong trends, and the problems occurring in the weak-trend phases of 2000 and 2004 remained manageable. So is the drawdown when compared to the profi t. Expenses and slippage are irrelevant with such a long-term trend follower. But the DAX itself is not tradable. That is why you can see in Figure 5 how the same system performs with the same settings and the future as a trading instrument.

It must be mentioned fi rst that this is a backwardly adjusted futures history. The differences between two consecutive futures maturities were calculated in this sequence of data. Thus the result refl ects the real trading result to be achieved. To simplify the comparison with Figure 4, a futures point was calculated at one euro (instead of 25 real euros). However, this adjustment of the future also causes part of the strong trend between 2003 and 2008 to be lost. Whereas the index was able to achieve tops in 2008 that matched the tops of 2000, its adjustment caused the future to fall nearly 1000 points short of the tops achieved in 2000. And 1000 points fewer in

F5) SPS on the Backwards-Adjusted DAX Future

In principle, the two charts look similar. However, the rollover adjustments of the future cause the trend to be weaker by 1000 points between 2003 and 2008. This and the discrepancies in the price development between future and index cause the performance to have worsened in the years mentioned compared to the index model.


the trend are obviously refl ected in the equity development of the system. Even though in this case the signals between index and future are very similar, the future can earn the system markedly less than the index system. This effect is visible especially between 2003 and 2008.

SummaryTrading systems require extensive tests prior to being used. How precisely was the historic performance simulated? Were expenses taken into account? How much slippage is estimated per trade? Which trading instrument was used for testing and which instrument was used to implement the system? How large was the historic drawdown and how long did it take for the system to recoup that loss? Do not ignore any of these questions and don’t assume that you of all people are capable of trading the system without slippage. However, if you still like this system after all these refl ections and if its risk fi ts your portfolio, use it! Nothing is worse for a trader than seeing how the system performs on paper but fi nding that they themselves have not consistently implemented the trades.

F4) The Swing-Point System on the DAX Index

The chart shows the performance of the swing-point system on the DAX index. Now the question is how you manage to implement this system in the real-life market environment; after all, the DAX index itself is not tradable.


For Traders, Not Gamblers

Trading on Sports Exchanges

A growing number of people are learning to successfully trade football matches and horse races exactly as they would do traditional financial markets. Why? Well, this is a market where you can find regular price swings of over 30 per cent every ten minutes, where you only pay commission on a successful trade, where there is no spread, where you have direct market access and where transaction costs are small. Welcome to the world of the modern sports trader.

22


TRADERS´ INSIGHTSTRADERS´ INSIGHTS

F1) Betfair Sports Market

The screen shows a section of the market, as displayed on Betfair, for the 15.55 race at Wetherby on the 29th October. The favourite is Domtaline, ridden by Ruby Walsh. At this particular moment in time, the horse can be backed at odds of 2.94, and laid (offered to others in the market) at 2.96.

Source: www.betfair.com

Until recently, sports markets have not been viewed as anything like a trading market. But the advent of betting exchanges changed perceptions signifi cantly. It heralded an age where sports risk could be traded in similar ways to traditional fi nancial instruments.

How Did Sports Trading Develop?At their core, betting exchanges offered people the simple choice of backing to win or laying to lose any selection in a sports market. They also cut out the middle man by allowing users to place orders directly on the exchange which were then matched by other users, rather than a bookmaker. Underlying that simple concept though was an accidental creation, a mechanism that acts more like a traditional fi nancial market and one that is very intuitive if you are already a trader on fi nancials. Modern sports markets are much more similar to a spread betting market than a gambling medium. But they also possess some key advantages over the latter.

The intial attraction of betting exchanges was that better odds were available to traditional gamblers. But as liquidity grew, shrewd users started to trade the movements of odds on the exchange. These participants did the same thing as in a traditional fi nancial market. They made a

judgment on the direction of the movement of those odds and ‘traded’ them just like a spread bettor. As a result traders now account for a large amount of the volume on betting exchanges.

When you place an order on a betting exchange, you are essentially buying or selling risk. The risk you are trading is the risk that something will or won’t win a sports event. It is like trading insurance risk. When you lay on an exchange, you are effectively ‘selling’ a risk premium and you are willing to put up some potential liability in return for that premium. When you back you do the opposite. If you view the market in such a manner, your objective becomes clear. It is to offer the lowest liability when laying and accept the highest payoff when backing. Your clear objective is to lay at a lower price than you back at or vice versa. When you do this, you net the difference between the two in profi t.

Trade ExampleIn the illustration of a sports market (Figure 1) we have traded a horse race. In this race we have entered two trades. First we laid £1000 at a price of 2.63, we then backed at a price of 2.28 completing our swing trade (Figure 2). When we laid we accepted a premium of £1000 for offering potential liability of £1630. When we backed at

F2) Our Trades

We laid Domtaline at 2.63 (pink bar), accepting a stake of £1000 for a potential liability of £1630. After waiting for Domtaline’s price to drift out to 2.82, we backed it with a stake of £931.93 for a potential profi t of £1698.08 should the horse win. The difference, £68.08, is secure.


Peter Webb

Former City Trader Peter Webb

was one of the very fi rst people

to use Betfair, back in June

2000. In 2005 he launched Bet

Angel (www.betangel.com),

a comprehensive software

solution for sports exchange

trading. Peter has run regular

seminars on advanced sports

trading techniques since 2004

and regularly writes for the

Racing Post on the subject.

23


TRADERS´ INSIGHTS

a higher price we only needed to place an order with a value of £931.93 and we now net the difference between the two, £68 in profi t, across the market. Because we have done this even before the race has started we are now assured this profi t regardless of what actually happens in the race itself. This trade took just a couple of minutes to complete. You can see the total amount of money matched in this market was over £1m (Figure 3), so our stake total of just short of £2000 is very small compared to the amount actually traded in this market.

How to TradeTraders on betting exchanges generally do not care much for the underlying sports or its participants, they are just looking to buy and sell at two different prices, so it is really not that different to a normal spread betting market. There are several key differentiators however. The fi rst is that the betting exchange model charges commission only when you win, not when you lose. You also have direct market access, so you are free to place orders anywhere on the exchange; you can make the spread if you wish. The current model also has minimal transaction costs. The big advantage to this is that you can place and pull orders at high frequency across the book,

at will, with little or no cost with obvious benefi ts. Trading risk on a sport may seem odd, but it is really absolutely no different from spread betting on commodities, foreign exchange or equities. All you are talking about is a slightly different product and market.

One of the most popular markets on the exchanges is horse racing. Horse racing is popular for many reasons. It generally has good liquidity and the markets are also very volatile, this opens up some excellent trading opportunities. These liquidity and volatility characteristics occur up to 15 minutes before the start of the race as people start to discount and anticipate the chance of the horse winning the race. Earlier in the day there is little interest in the market and it is very illiquid. Liquidity peaks just before the start of the race and tends to be fairly exponential to that point. There are typically three to four meetings in the afternoon in the winter and there can be double that in the summer with evening racing. Each race goes off at ten minute intervals during the day, so you can choose to trade all or just some, as another will follow just after. Trading hours tend to be between 12-9pm UK time depending on the time of year. Of course, you can trade any sport, but each market and the time at which you get involved and the reasons why vary quite a lot.

Sports have two periods that

you can trade, before they start and in-play. Inplay markets rely much more on what is actually is happening in the underlying event and are therefore considered more specialists areas, as you need to make a judgment on the actual sport itself. Some markets do exhibit characteristics that you may be more familiar with. Football matches are time limited and therefore the odds exhibit a discounting of the time value of the underlying event. Odds will move in much the same way as an option. Even if the underlying instrument, the score of the football match, is unchanged the time to the end of the match will force the odds to move. If you are an options trader then you may fi nd that this is an interesting area to explore.

ConclusionThanks to the way they have developed, betting exchanges now exhibit liquidity reaching billions a month. Trading on sports markets is an unusual but complimentary area for traditional fi nancial traders. Many have yet to fully understand its potential but, in my experience, traditional fi nancial market participants take to these markets much better than the gamblers that they are generally marketed to.

F3) Betfair Chart and Summary

This summary of the activity on the race shows that over £1million was matched between backers and layers. The graph shows the prices matched and the volume of bets at those prices over time.


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The room is run by Tom Hougaard and David Paul.The room has a one year, transparent profit

history, which is clearly displayed on the www.whichwaytoday.com website. Each trade is relayed to each room member instantaneously and is complete with stop loss level and profit target.

In the room the trades are classified into two main categories. These are intraday and swing

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the WhichWayToday live room is like going on a course in trading in each day that someone else (the markets) pay for.

In the last week of each month WhichWayToday run a two day workshop. Here the emphasis is on

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25


TRADERS´ TOOLS

Alpari introduced Alpari FX Options, a new trading platform, to its line of trading products. Powered by FX Bridge Technologies, the platform combines existing multibank Currenex spot Forex liquidity with options pricing from their banking relationships. The company has been implementing its global expansion plans with new products bridging the gap between retail and institutional clients. For further information, visit www.alpari.com.

The international derivatives exchange Eurex launched its latest software release. Eurex Release 13 provides members with more fl exible clearing solutions, new risk management functionalities and comprehensive enhancements in the trading layer, for example a new optional interface and

a further optimised matching system. The risk management features included in Release 13 contribute to European and U.S. regulators‘ goals of achieving higher safety and stability of fi nancial markets. The main components in the clearing and risk management areas are a client asset protection solution and new pre-trade risk management tools. The client asset protection solution will enable Eurex Clearing users to choose among different

segregation levels for their accounts based on individual needs. Introduction is planned in the fi rst half of 2011. The new real-time pre-trade risk management service called Advanced Risk Protection will enable members to set maximum risk limits for instance based on the total margin requirement or cash fl ows. Additionally, Eurex‘s Wholesale offering has been improved. Eurex customers are now offered enhanced close-out

procedures for fl exible contracts transactions while the Multilateral Trade Registration facility has been adjusted to make it easier to track and process trades post execution. The new optional Enhanced Confi rmation Solution gives members the ability to receive recoverable order, trade and matching event

information independent of the current MISS architecture. The new, FIX-compatible interface is based on the same technology

as Eurex‘s existing Enhanced Transaction Solution interface. Other technology advancements include further latency reduction and greater price granularity. Additional details can be found at www.eurexchange.com.

John Bollinger‘s BBForex.com, which provides free Bollinger Band analytics for the forex community, has added a revolutionary new way to compare currency prices. BBforex now features a patent-pending 3-D model which provides a unique new way of

NEW

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TradeStation has acquired Portfolio Maestro´s Portfolio Testing software technology from Rina Technologies. The purchase includes all versions of Portfolio Maestro, together with many of Rina´s legacy portfolio testing, reporting and analysis products. Portfolio Maestro will be integrated with TradeStation´s trading strategy design, backtesting and automation platform. One of the two lead investors of Portfolio Maestro will serve as a part-time consultant, while the other will be joining TradeStation full time. For more information, please visit www.tradestation.com.

Real-Time Analysis and News Ltd., poviders of the RANsquawk service, announced they would provide Forex traders around the world with live audio fi nancial news reports over the Internet via a new portal, Talking-Forex.com, delivering global economics, market analysis, commentary, and alerts tailored to the Forex marketplace. The commentary fi lters the massive quantity of constant news and other information hitting more than 100 different newswires throughout European and US trading hours. The company also said it would offer real-time headlines, daily written macro analysis, and video pod casts. Additional details can be found at www.talking-forex.com.

comparing and visualising currency price changes relative

to one another. The model allows for rotation along different axes, zooming and out, and shifting the model in 3-D space. The multi dimensional feature is easy to use. Users select the currencies to compare, choose the colour for each and the system creates a forex chart which graphically presents the history of currency prices in a choice of 2-D or 3-D. Users can select a specifi c time range and the controller allows easy manipulation to speed up or slow down visualisation of the data over time. Additional features of BBForex include:

interactive charts with multiple indicators and the option of news headlines shown on the charts, forex Grid with streaming forex rates and mini pop-up charts for easy visualisation, lists of currency pairs that meet the criteria for two Bollinger Band trading systems, portfolio section to create multiple personal portfolios for easy monitoring, and Bollinger Band tutorial explaining how to effectively use Bollinger Bands for the forex market. The website is free to users and can be reached via www.BBForex.com.

26


TRADERS´ TOOLS

High Probability Trading Strategies

By Robert C. Miner

Trading today’s markets – including stocks, futures, or Forex – can be a challenging and diffi cult endeavour. But it is possible to achieve consistent success in this fi eld, if you are prepared with a complete trading plan and to stick to it. In “High Probability Trading Strategies”, author and well-known trading educator Robert C. Miner skilfully outlines every aspect of a practical trading plan – from entry to exit – that he has developed over the course of his distinguished twenty-plus year career. The result is a complete approach to trading that will allow you to trade confi dently in a variety of markets and time frames.

Written with the serious trader in mind, this reliable resource details a proven approach to

analysing market behaviour, identifying profi table trade setups, and executing and managing trades. With this book as your guide, you will quickly learn how to recognise high-probability trading opportunities, pinpoint exact entry and stop prices, and manage a trade until it is completely closed out. As you become familiar with the proven strategies and techniques taught in the book, you will also come to understand the type of market information you can use to make specifi c trade decisions and how to execute those decisions from start to fi nish.

High Probability Trading StrategiesThe book is divided into two major parts. The fi rst part introduces different trading

strategies and the second part shows how to trade them in practice.

Let us start with the fi rst part. Here you will discover the four dimensions of market position: multiple time frame momentum, pattern, price, and time. Each factor provides an important piece of information you will use to make a trading decision. A trading plan that does not include these four market dimensions is missing a big piece of the market puzzle and is much less effective. For this reason, every dimension gets its own chapter where Miner explains it exactly. He starts with momentum. For this, he presents a momentum strategy that will teach you how to use the lagging momentum indicators as a powerful technique as a fi lter for trade direction and execution setups.

In the next chapter, Miner deals with the second dimension “pattern”. He introduces simple guidelines based on Elliott wave structures to identify frequent patterns for all markets and all time frames. One simple guideline will instantly reveal if a market should be in a trend or countertrend and thus, can make a signicant difference in your trading results.

After this lesson, you will be able to quickly recognise the probable structure position of any market and any time frame. Most traders are familiar with Fibonacci

(Fib) price retracements. Like a single time frame momentum study, they are not of much practical use by themselves to make a trade decision. Chapter Four teaches you how to identify in advance which retracement level is likely to complete a correction in any time frame. It also teaches how to project the probable trend targets in advance to be prepared for the price level at which a trend should be complete. Besides, you will learn some new ratios that are not part of the Fib ratio series that are a key to correction and trend price targets. Once the reader has learned Miner’s Dynamic Price Strategies, he should be prepared not just for temporary support and resistance levels, but for the specifi c price levels for trend and countertrend reversals.

The next chapter is about time respective market timing. The author describes his Dynamic Time Strategies which will allow you to project the probable minimum and maximum time targets for a trend reversal. You will also learn how to project time bands in any time frame to target a relatively narrow time range with a high probability of trend change.

After you have learned these four key factors preparing you to recognise optimal trade conditions, Chapter Six presents two completely objective entry

Title: High Probability Trading Strategies

Subtitle: Entry to Exit Tactics for the Forex,

Futures, and Stock Markets

Author: Robert C. Miner

ISBN-13: 978-0470181669

Price: £47.50 / €56.00

Publisher: John Wiley & Sons

Pages: 288

About the authors:Robert C. Miner has been a leading trading educator for more than twenty years and publishes daily reports on the Forex, stock, and futures markets. He speaks around the world on trading and has written for a wide variety of trading publications. Miner has been named „Guru of the Year“ and is a fi rst-place winner of a major brokerage company‘s annual real-time trading contest.

BOOKREVIEW

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TRADERS´ TOOLS

strategies and how to quickly determine the maximum position size for any trade. Every successful trader knows: the proper position size for any trade setup on any time frame is one of the most important keys to long-term success for the trading business.

Miner calls Chapter Seven as the heart of his book. Here you will learn to apply all of the practical strategies, from recognising high probability trade setups, to the specifi c entry strategy, stop-loss adjustment, and exit strategy. In other words: it teaches you how to manage a trade from entry to exit.

Trading the Plan After you have acquired the necessary theory and know-how, you are ready to learn how to use these strategies in practice. Miner offers some trade examples from students he has taught over the past 20 years. These examples from other real-world traders show how what you learn in this book is being put into practice every day. And it gives advice on how to use the strategies and important key factors in your trading and how you can improve them. In addition to Chapter Eight, the next chapter offers more insight into the business of trading. It will help keep you

on track and on the road to a successful trading business and offers advice on how to treat trading like any other business. It shows how to get routine into your personal trading plan. To put it briefl y: The second part of High Probability Trading Strategies gives you practical advice for your every day trading.

Video CD – A Useful Book BonusIn addition to the book, you get a bonus CD with over two hours of bar by bar examples of several markets and time frames from entry to exit recorded especially for the book. It is not a word-for-

word review of the material in the book, but rather an additional tool to illustrate more examples. With it, you will learn how to put high-probability trading strategies into practice, day by day and bar by bar for many different markets and time frames.

ConclusionRobert C. Miner teaches in a practical, step-by-step-manner how to develop a complete trading plan from entry to exit for any market and any time frame. The book does not cite a few well-chosen examples of isolated trade setups and strategies but instead shows how to recognise

optimal trade conditions, objective entry strategies with the exact entry and exit price, and how to manage the trade with stop-loss adjustments to the trade exit. While the ideas found here are essential to trading success, the best way to learn is by example. That is why Miner has devoted an entire chapter-called “Real Traders, Real Time” – to trade examples submitted by his former students. A companion video CD completes this comprehensive learning package.

www.tradersonline-mag.com

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TRADERS´ TOOLS

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W A Stroke of Genius?Wave59 – for Traders by Traders

Wave59 was originally developed as Wave59 RT in 1997 by Earik Beann, a CTA at the Chicago Board of Trade, as a result of his being unable to find a trading & analysis platform that did the types of advanced analysis he desired. He needed a robust platform that would allow him to implement geometric time & price patterns, predictive price forecasts and advanced technical analysis beyond conventional oscillators and rule based systems. Nothing like that existed in the marketplace, so he built it. Almost 13 years after he first developed this software, Beann saw a need to rebuild the platform to take advantage of newer, faster computers and build in something revolutionary – an integrated, institutional-quality data feed. The result is a faster, more powerful Wave59, with RT replaced by three different platform options, EOD, PRO and PRIVATE. It is an effective trading platform for a variety of markets and instruments, including Futures, Forex, Options, Commodities and Equities.

Advanced Trading Platform FeaturesWave59 is a trading platform with an extremely broad array of tools & indicators. Many of these are advanced versions of standard indicators, while others are completely unique to Wave59. It would be impossible to cover all the features in the space of this review, but we have attempted to cover a wide range of them.

Technical IndicatorsAs with most trading platforms, Wave59 has the usual indicators such as moving averages, RSI, and momentum, but also

contains enhanced versions of all of them. They were designed to be smoother than the originals while removing as much lag as possible. By using two or three of these indicators together, such as Ultrasmooth Momentum and Predict, you can literally be one or two bars ahead of other traders using the older indicators. In fact, these indicators do seem to work very effectively when used in combination with each other. Other indicators such as the Fractal Trend Index and nine-fi ve count (proprietary/unique to Wave59) can be used effectively as well.

Info

Users can lease or buy all three versions:

Lease info: EOD: $149/month + exchange feesPRO: $249/month + exchange feesPRIVATE: $299/month + exchange fees

Purchase info: EOD: $2750PRO: $5700*PRIVATE: $7500** a monthly charge of $90 + exchange fees is also required

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TRADERS´ TOOLS

Geometric Patterns and Pattern MatchingWhile pattern matching is a tried-and-true method of chart analysis, one challenge to doing so with geometric patterns is an inability to properly scale a chart and maintain this scaling while resizing. Wave59 has engineered a solution to this, making patterns easy to use and analyse. An example on the S&P E-mini follows; in Figure 1, the Flower of Life pattern, built on many repeating triangles, is placed

on points A and B, and is then used to forecast

the time of the next turn, which is point C. According to Beann, simple patterns such as triangles, circles, and squares can be used to forecast turning points in the future with high accuracy on a chart that is properly scaled. In this example, the four-minute ES chart is scaled so that the width of each bar on the X-axis (in screen pixels) correlates to the same amount of space used by 1/8th of a point of price movement on the Y-axis. Wave59

is the only real-time charting application available that can create charts with these types of detailed Price-Time relationships, which Beann claims is the key to making geometric patterns work. Note that Points A and B themselves were also forecasted using a similar approach from previous swing highs and lows.

Another useful pattern tool in Wave59 is the Fibonacci Vortex™ (Figure 2). Wave59 owns a proprietary copyright on this pattern, which provides support/resistance turning point forecasts for both time and price. Those familiar with Fibonacci trading will be familiar with the Golden Spiral;

the Fibonacci Vortex uses four Golden Spiral patterns to pinpoint time and price turning point

levels. Once again, the ability of Wave59 to properly scale a chart is integral in the effectiveness of the Fibonacci Vortex.

Custom ScriptingMany platforms include a programming language that allows the user to write custom indicators. Wave59 features QScript™, a proprietary, open language which was designed by the company specifi cally for building trading indicators.

Relative to most of the scripting languages on the market, QScript is user-friendly and straightforward in its syntax, and Wave59 includes a built-in QScript tutorial as well. QScript’s ease of use has led a number of Wave59 customers to write their own indicators, many of which are shared in the Wave59 QScript Library and online Discussion Forum.

Artifi cial IntelligenceWave59 has an interesting artifi cial intelligence module called Hive Technology™ that is based on ‘swarm theory’ of computing (Figure 3). Much like bees in a hive, the program solves big problems by breaking them into lots of little problems that are then addressed by different aspects of the program, working together and all at once. Hive Technology can be used to construct a trading system by simply selecting a series of indicators and setting the desired parameters – the Hive does the rest of the work and allows for backtesting through a system report. Once the desired equity curve has been achieved, the Hive can then be used to trade in real-time, either manually or even automatically through use of QScript (see above) and a connection to an account with one of Wave59’s featured partner brokers. Once constructed, a Hive is highly customizable, as

F1) Geometric Patterns

F2) Fibonacci Vortex

The Flower of Life Pattern predicting the next turn in Wave59.

Source: www.wave59.com

Using points A, B, and C, a Fibonacci Vortex was placed to forecast the location of point D, the low of the year in Microsoft.


Earik Beann

Founder of Wave59

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TRADERS´ TOOLS

the system is written in QScript and the code accessible to the end-user.

Platform FlexibilityA regular complaint of traders is that the platform they use is infl exible and prevents them from being able to do the kinds of analyses they desire. Earik Beann, a trader himself from a young age, built Wave59 with maximum fl exibility. He wanted to be sure that everything can be realised. Control over chart styles, visual elements (bar thickness, chart colors, spacing, etc) and perhaps most importantly, indicator parameter settings allow users to customise and manage Wave59 to a degree not seen in most other platforms.

Platform ArchitectureOne of the biggest changes between Wave59 RT and the three new platforms is “behind the scenes” in the platform’s architecture. Wave59 was rebuilt from the inside, restructuring the program to take advantage of quad-core processors and allow for multi-threaded calculations, meaning that Wave59 is now faster, more effi cient and powerful. Other key improvements over the original platform include:

• graphics acceleration• unlimited historical data

• implementation of newer Windows components

• a complete redesign of the graphical user interfaceThe improvement to the trading experience is substantial relative to Wave59 RT.

Institutional Quality DataPerhaps one of the most powerful aspects of the new Wave59 platforms is the fully integrated, institutional-quality data feed. Beann had had enough of the problems inherent in most of the available retail feeds so he partnered with a major institutional data vendor to provide Wave59 with a built-in feed that would be as fast, accurate and reliable as the feeds the big trading houses use. Wave59’s monthly subscription fee to the PRO and PRIVATE Platforms includes this data feed, with exchange fees the only additional cost. Wave59 states that they are unable to reveal who the data vendor is due to a non-disclosure agreement, but claim that their new feed is cleaner and faster than anything available in the retail segment, and have gone as far as fi lming their data feed side-by-side with industry standard retail feeds to prove the point.

Three Available PlatformsWave59 is available in three platforms; an End of Day (EOD) version and two real-time versions (PRO and PRIVATE).

Wave59 PRO is the base real-time version and is suitable for most intraday traders. Wave59 PRIVATE contains a number of advanced indicators & tools from Earik Beann’s two books “The Handbook of Market Esoterica” and “Techniques of an Astrotrader”. As mentioned earlier, Wave59 has a very broad array of features, tools and indicators, and the methods described in these two books and available in Wave59 PRIVATE have not been covered in this review. Wave59 states that all updates to the platform are always free, and that new features and functions are being added all the time.

ConclusionWave59 has a large number of powerful features, which provides traders the ability to test and determine the particular tools best suited for their particular strategy. With such a broad list of features, it can take a short time to determine how to best utilise the platform. It is time well spent, as the tools & indicators are effective at helping to determine turning points in advance. Because it has a built-in institutional-quality data feed, traders can feel secure that the information guiding their decisions is solid.

F3) Trading System Using Hive Technology

An equity curve resulting from a Hive trading the S&P E-mini.


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TRADERS´ TOOLS

www.tradesignalonline.com

Tradesignal Online – Professional Chart Analysis on the Web

Tradesignal Online, the interactive platform for technical chart analysis and professional trading, recently celebrated its 10th anniversary. Tradesignal celebrates its anniversary by introducing innovative features and a fresh online presence. Let’s take a tour of the site to see just how much Tradesignal Online has improved with this new release.

The HomepageTradesignal Online’s homepage is clear, intuitive and informative. Key markets are displayed in the centre of the page as mini charts, which, with a single click, can be opened immediately as full-screen charts. A list provides additional securities that with just one click also open-up as charts. Additional sections provide analyses, current discussions from the forum, and the latest business news. A tag cloud shows the most popular portal securities. The most important feature, however, is the sidebar,

found on the left side on every page, allowing users to search for and access market prices. The top of the sidebar has a full-text search for securities, which can also be accessed via symbol lists. Search results and selected symbol lists remain on the sidebar no matter where you navigate on the website.

A quick glance at ‘symbol lists’ reveals that the number of available quotes on Tradesignal Online is truly comprehensive. Quotes include: stocks and indices, foreign exchange, commodities, futures, certifi cates,

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F1) Start Page

Tradesignal Online’s homepage provides an instant overview of key markets and news. A securities search provides a comprehensive choice of quotes.


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TRADERS´ TOOLS

ETFs and many more, leaving not much to be desired. Some of the data provided here is displayed with a delay of up to 15-minutes, so users who require real-time data need to subscribe to corresponding packages. Registered members also have access to intraday charts.

Having selected a security in the search fi eld, we are now ready to test the charting tool.

ChartingSelecting a security opens Tradesignal Online’s charting area. At this point you will recognise the fi rst bonus feature: the presentation of instruments

and arrangement of items in the sidebar create the feeling of an application rather than that of a website. The page automatically adjusts to the screen size. Being able to open several browser windows at once allows you to create your own unique market overview with various charts on trading screens.

If you are a new user, all you have to do is open a free account to store the charts you have created. It is quick and well worth the time as logged-in users can store up to 50 charts in their individual chart overview, allowing them to organise and manage them as they wish. Charts can be

refreshed with a simple click, or automatically by subscribing to a fee-based service.

But let us go back to the charting area: the previously mentioned sidebar on the left side expands, providing you with new functionalities and information about the selected security. In the top section you can choose from a multitude of indicators and trading system modules and apply them to your charts.

It is here where the next bonus feature is revealed: every indicator and trading system can be adjusted individually in an editor with an integrated Syntax

F2) Chart Overview

The chart overview allows users to manage individually created charts and compile them to create a unique market overview. The new label system lets users assign charts to multiple areas.


F3) Chart

The charting area of Tradesignal Online looks like an application. The sidebar displays a comprehensive set of data for the selected item.


Your Point Of Entry ToFinance and Media Industry

Please send your application via e-mail to: [email protected]

Freelance Authors

Ideally you should be a practical trader and have considerable knowledge of technical analysis and all the related subjects like risk and money management, trading software, trading systems and trading psychology. You will work from home, on your own time-schedule and submit articles at specifi ed deadlines.

TRADERS is a premier publisher of trading magazines for the � nancial markets. Our vision is to o� er an international platform for industry professionals and serious traders alike.

www.traders-mag.com

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TRADERS´ TOOLS

Highlighting tool. The formula language used by Tradesignal, Equilla, is comprehensive. The portal’s lexicon provides tutorials for how to use this tool.

The lower sections of the sidebar allow you to select various pieces of information for your quotes. In addition to the relevant securities displayed as a list, current discussions regarding price and latest business news are also shown.

A practical point: charts processed and stored can also be provided to other users who can then view or manipulate them further.

Below the charting window you will once again see exact details about the security, and will be able to select related securities within a drop-down menu. Like the sidebar, this area can be closed at any time to increase the size of the chart area.

In the menu above the charting windows you can fi nd all the commands relevant to the charts. There are 15 chart types and 18 easy-to-use tools, everything from trend lines to Fibonacci variants. The sidebar on the right allows you to change the parameters and chart design, and the integrated tools and indicators. Here you can also set variables for Money Management.

The ScannerTradesignal Online provides its users with a free scanner that allows German and international market lists to be scanned with one of the many indicators. Let’s give it a try and select “Dax 30” from the market list, adding the

“Candle Pattern” indicator. After a few seconds the result list appears which can be fi ltered further with various sliding bars. If you are in a rush, key markets and their most frequently used indicators are already available as ready-to-use Quick Scans.

The Forum Tradesignal Online’s forum is carefully structured and sorted by markets, trading methods and special Tradesignal themes. Charts posted by other users can be opened with one click and used in the Chart-tool. These are, therefore, not simple graphs but interactively usable chart templates. If you take a closer look at the threads, you will notice that some of the discussions have been going on actively for

F4) Codeeditor

Tradesignal Online turns every user into a programmer because every indicator and trading system can open a code editor that allows adjustments to individual elements.


years, proving that this is a lively community.

ConclusionThe free analysis and charting tool provided by Tradesignal Online is, without a doubt, solid. The new version provides

effortless, user-friendly and intuitive navigation and has the additional benefi t of enhanced functionality. If you are used to the old version of the site, take some time to get used to the new

design and the new location of some of the tools in the charting area. Once you are trading live, everything must be fi rmly in place.

Users with limited experience in technical analysis are also in good hands with Tradesignal Online as it includes an extensive lexicon area and a well-attended forum that provide a seamless entry into the system. Furthermore, the company has provided its users with free code packages to optimally supplement their individual trading strategies for years. And, of course, support is always at hand if you have any questions.

Tradesignal Onlineprovides its users with a

free scanner

Price and Volume Sensibly Combined

Better Trading with Candlevolume Charts – Part 1Integrating volume into the candle chart makes price patterns more meaningful and offers a maximum of information for analysis. It is the best possible optical processing of price and volume descriptions.

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TRADERS´ STRATEGIESTRADERS´ STRATEGIES

What Is a Candlevolume Chart?Traditional candlestick charts offer a distinct variety of opportunities for analysis. Of course, all the rules remain in place when using candlevolume charts. While a candlestick chart typically lists volume as a histogram below price development, a candlevolume chart, closely following Richard W Arms’ equivolume chart, optically shows volume across the width of the candles. The goal is to optically recognise the relative size of the volume right away.

The width of the candle does not make it possible for the exact size of the volume to be read, but then that is not the direct goal. Rather, this is all about geometrical fi gures and the change in form undergone by individual candles. The ability of human beings to perceive pictures faster than numbers or letters, is an advantage that is made full use of here. Figure 1 shows the optical change of the candles vis-à-vis candlevolume. Candlevolume charts provide

Christian Lukas

Christian Lukas studied

economics and engineering and

has been devoting himself to the

markets since 1998. His central

topic is personal trading of

DAX-Futures and Bund-Futures.

Derivatives are only traded via

automatic trading systems.

Within these trading systems

volume is the most important

factor in producing signals.

Contact:

[email protected]

a maximum of information to assess supply and demand. The technique can be used for all time levels but with an inevitably distorted time scale. Given a constant candle width, the X-axis of the traditional candlestick charts is also equipped with a linear time scale. If you change the width of the candles – because of the varying volume –, there cannot be a uniform time scale. That is why, for example, fi bonacci time projections cannot be used any more in the candlevolume chart. Projections based on the constant price scale continue to remain valid (for example fi bonacci retracements). In general, all the price-time analyses are suspected of being unusable. That is the major drawback that needs to be paid attention to when using candlevolume charts for descriptions.

Waves in the Candlevolume ChartIf we consciously set aside individual candle formations and concentrate on the overall picture

F1) Optical Alteration of the Candles

On the left and right, exactly the same period of time is represented. The low point is marked by a hammer. The downward movement with relatively broad candles suggests a short-term but pronounced sell-off urge. The hammer is followed by a “cautious” upward candle which is relatively thin and shows the cautious efforts of the bulls. But right after that the bulls gain new confi dence (broad candle). At the end of the upward movement the candles become narrower again suggesting reduced demand.


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TRADERS´ STRATEGIES

of the candlevolume chart, we will have a wave picture that allows individual waves to be forecast. Since the majority of high-volume waves generate a subsequent wave in the same direction, even predictive forecasts are possible.

The ideal wave picture is marked by an initial wave with broad candles, followed by a narrow consolidation wave which subsequently reverses course to turn into a continuing wave (same direction as the initial wave). In practice, this is not always the case but as a rule of thumb, it is an appropriate statement to make.

In Figure 2 four upward waves are marked with arrows. The fi rst wave is a strong reaction to the sell-out mood in October 2009. The candle of the wave (1) starts with a decent width and length. The longer the wave (1) lasts or the higher it rises, the less interest the market participants have, as can be seen from the candles, which become narrower the higher the price rises. This is followed by a reaction with dynamic downward candles. The reaction to Wave (1) ends with the broad green candle announcing the start of Wave (2). Unlike Wave (1), Wave (2) ends with a high-level broad green candle. This clearly is a fi rst sign of buyer interest – despite the high-price region of 2800. After Wave (2) the bears are already exhausted after two red

candles. The next short upward wave (3) continues to indicate the bullish tendency of the market with broad candles. Wave (4) is the perfect example of a weak upward wave without any special buyer interest. Quite clearly, the candles describe a marked lack of demand here. Despite this, prices continue to rise and do so relatively long without the bears fi ghting back. Wave (4) then ends at the level of around 2950. This is followed by aggressive sellers entering the market.

The ability to analyse by using wave formations with candlevolume charts is one of the major advantages over conventional candlestick charts. The weak volume of the last wave (Figure 2, No 4) would have been easy to overlook if one had only relied on regular candles. It is quite common for the volume histogram to be placed under the conventional candlestick chart, but only by expending considerable analytical effort could the differences between the waves have been recognised. By contrast, the candlevolume chart makes it possible for these differences to be detected.

Candle Shapes at Breakout and ReversalThe candlevolume chart provides certain clues to the chances of a breakout. An underlying principle is the claim that there

is an increased probability of a breakout if, for example, the candle is broader at a bullish breakout than the candle previously forming the high. A rule of thumb is that a more than ten per cent higher volume is desirable. As of this marginal value, the statistical probability of a breakout rises to slightly more than 50 per cent. Obviously, in practice there are also other examples where volume was smaller during a breakout, but the risk-reward ratio is simply worse should a trader put his money on this market situation.

Volume difference is a clear indicator of the will of the market participants. Each new high always produces veteran market participants anxious to sell. This selling interest needs to be matched by new buyers for a breakout to remain successful. An increased volume in a new high means nothing other than that the market considers a higher price to be fair, matching selling interest in the process.

In a market reversal there are two signifi cant behaviour patterns that are important in the candlevolume chart, which is particularly true of stock markets. The fi rst reversal happens relatively slowly, i.e. when prices enter a downward direction with the candles showing alternating red and green candles over a longer period of time. The width

The waves marked with an arrow are of a different character. Wave (1) starts out strongly and ends weakly. Wave (2) is short. Wave (3) is likewise short und ends again with a broad candle. Wave (4) shows the end of the bullish forces. At the end of Wave (4) there appears a reversal, resulting in a panic selling urge.


F2) Wave Formation in EURO STOXX 50 Future

37



of the candles may vary, too, and can generally be regarded as changeable. The shape of the bearish reversal can be perceived as a ”roof”, and Figure 3 shows two such roofs. The second variant, the bullish reversal, is more dynamic and V-shaped. It is often accompanied by high volumes, and in the example chart (Figure 3) such a reversal can be seen on 1st September. Downward volume is so heavy that the sellers in the market are being absorbed, as it were, by the market around the price level of 1000. When volume is light, the upward movement is resumed. The bullish V-shaped reversal resembles a sell-out. In general, reversals can form other shapes – but in stock markets the shapes described above can be found very frequently.

Gaps in Candlevolume ChartsGaps are excellent instruments for assessing the mood in the markets. In all the major markets, where there is no 24-hour trading, the opening prices are a barometer for a re-evaluation of the markets. There is no other price throughout the day where psychology is this dominant.

A major advantage of the candlevolume charts is the simpler analysis of the gaps, of which there are four variants in scholarly literature. In a conventional candlestick chart

the distinction is only possible within the overall context of the gap. More often than not, two candles are enough in the candlevolume chart to identify the principal direction.

Figure 4 illustrates the ideal candlevolume forms of the gaps.

(A) Trading Range GapThe trading range gap originates from a major trading range between a strong resistance and a strong support. The price jumps within this range but usually bounces off the limits again. The vast majority of the trading range gaps is irrelevant to future price development. Even the resistance and support lines are frequently not even attained. The candle widths can be classifi ed as being irrelevant. This means that trading range gaps fall into the random category, both in the shapes of the candles and in their effect on the future direction.

(B) Breakaway Gap The breakaway gap generates a dynamic gap and determines future price development with the price skipping the resistance or support line of the consolidation phase. Ideally, the previous candle is narrow and the following one of more-than-average width. The

broad powerful candle should continue to keep future price development moving in the direction of the gap.

(C) Runaway GapThe runaway gap originates from a fast movement. It is the sign of a powerful wave and basically constitutes a continuation pattern for further price development. The market has adjusted to a trend with the expectations of the market participants causing the gap to originate virtually automatically. Typically the candle bodies are large and broad.

(D) Exhaustion GapAt the end of a movement an exhaustion gap appears, i.e. the movement is exhausted. The exhaustion gap frequently forms new resistance or new support for the subsequent prices, which must be broken fi rst. What is striking is the marked width of the second candle. Relative to its height, the body of the candle often is broader.

Beware of Certain Candlestick ChartsMost traders work with candlestick charts. Strangely enough, those who do a little research on the Internet fi nd lists of candle patterns having a bullish, bearish or neutral effect. Sooner or later, when dealing

F3) Typical Breakout and Reversal in the S&P

At the fi rst breakout (arrow) the candle is narrower than with the previous high. Hence, there is less probability of a successful breakout. At the next breakout the candle is broader (second arrow). A V-shaped reversal in excessive volume can be seen at the lower smaller arcs plotted in the chart. The respective sell-out tendency can be diagnosed by way of the “super broad” red candles.


Gaps are usually strong indicators of further price development. The candle patterns idealised here also exist – inversely – on the downward side. Especially the different lengths of the wick and fuse form diverse variations.


F4) Examples of Upward Gaps

38



with patterns on a practical level the observation can be made that the patterns always need to be interpreted. For example, it makes a signifi cant difference whether a harami appears in a trend or in a sideways market. Just to add to the complexity of the subject, it must also be emphasised that volume plays an important role in the candles’ ability to make any forecast. What many traders do not know: many candle patterns have lost their effect! Some textbook information suggests that no statistically relevant effect can be measured. What functioned at some point in the past may not

necessarily still function today. The statistical “messiness” is even more dramatic when selecting individual exchanges. As a matter of principle, the origin of a candle needs to be questioned. A healthy dose of distrust is justifi ed whenever analysts interpret certain patterns in the DAX or Dow Jones on a day’s basis. While the offi cial trading hours are the most high-volume ones, they do not refl ect the actual trading hours e.g. on the German stock exchanges since it is possible to trade longer on all other German exchanges. The DAX’s method of calculation, therefore, contains

major gaps. The DAX’s Xetra closing price is not infl uenced long enough by the American market which basically always dominates German afternoon stock-market trading. The fact of the matter is that the time period until 5.30 pm is simply too short. This means that it is questionable whether the DAX can be meaningfully represented at all. Those who wish to conduct a candle analysis of the DAX are much better off with the DAX Future (FDAX). It runs from 8 am to 10 pm, includes all American trading activity and shows precise candles. A wholly different set of problems exists

with the Dow Jones. Calculating opening prices does not correspond to real-life trading. There are virtually no gaps within the Dow Jones Industrial, but gaps do exist in real-life stocks. The upshot is: If the opening prices of the candles are inaccurate, you do not have any correct candlestick patterns either. Consequently, there will be a questionable candlestick interpretation with the Dow Jones as well. The alternative to this problem is high-volume futures or ETF‘s. This detour ought to cause candle-based analyses of the US market to make sense again.

Outlook Part 2In the fi rst part we talked about the interpretation of candlevolume charts and gained a basic understanding of this meaningful form of representation. In the second part we will carry out an evaluation of the most powerful patterns and make a brief assessment of each of them. In addition, we will discuss in which cases candlevolume charts may be unusable.

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A Simple Way of Trading

20 Pips a Day Is All You NeedMany traders strive for hundreds of pips a day, get frustrated they did not squeeze the maximum out of their trades, not sure where their exit points should be and so on. What traders forget to realise is that if you could bank as little as 20 pips a day, in a short space of time with good money management you could see your account grow considerably. In this article, we are going to show you a simple, yet effective way of trading. And not only that, tie this together with a good money management system and you could potentially crack the wonderful world of Forex trading.

40



Step 1: Separating the Sessions Firstly, we will separate the three major trading sessions, splitting them up into the following categories: Europe, US and Japan (Figure 1). We will treat them as totally different sessions. The main reason for this is you have an infl ux of new traders or a departure of traders in each session which can drastically change the trend of any currency. Why do you think in general when the US join the market at 12noon-2pm GMT till the European banks close at 4.30pm GMT we tend to see a lot more volatility? Simply because we have a huge percentage of the world’s traders trading during this period.

Step 2: Trend Recognition30 minutes or one hour from the open is not enough to determine the trend. Many traders will place a buy 30 minutes from the open


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as this is the direction they think the trend is going and then it suddenly reverses 30 minutes later and you have lost your fi rst trade and you are on the back foot from the open. Confi dence is important when trading. It is much easier to trade when you have won your fi rst trade of the day. Therefore, we do not trade the fi rst two hours of a session, we use this time to discover our trend. Many sessions open up one way and then switch so we give the markets time to show us the direction. Everything we do is to minimise our risk fi rst and foremost. The less risk, the greater the chance of success, so we try to factor out as many risky problems as we can before we enter any trades and giving the markets time to develop is a major factor in this.

What we do next is allow the price to move away from the sessions opening price. The

F1) Three Trading Sessions

This diagram shows how to split each trading day into three sessions. In GMT London time this is Japan 1am-7am, Europe 7am-12 noon, US 12 noon to 10pm.

Source: www.metaquotes.com

Info

Reversals will be smaller when the trading session begins. As time passes and we get deeper into the trading session the retracements will become bigger, especially if the trend continues to move higher.

41



further away the better. The minimum we would be looking for the currency to move would be at least 40-50 pips on the GBPUSD and 35-40 pips on the Euro and other pairs.

The next factor is one of the most important in our strategy and how we feel we determine the true trend for the session; after two hours we wait for a good retracement of 15-20 pips, maybe 20-25 on the GBPUSD and after this point we now want the currency to make a brand new session high or low depending on the direction it was originally travelling. This is our confi rmer, this tells us that we are going to trend that direction for the session. On trickier, volatile days, we may let the fi rst two retracements and new highs or lows be the confi rmers, just to be sure. We are always better safe than sorry.

Remember we are trying to eliminate the risk factors fi rst. To help us confi rm the trend for the session we must understand how correlating pairs work.

In Figure 2 we have the GBPUSD and EURUSD on the top and the USDCHF and USDCAD on the bottom. In an ideal day the top two will work in the opposite direction to the bottom two and we must study other pairs to truly determine the trend of the currency we are looking to trade.

If we have several pairs working in correlation we know we are limiting the risk even more as they tend to pull one another. When we are trending, and in correlation we normally always have one, maybe two currencies leading the way, the earlier we can spot this the better, as we can then look to enter on the lagging currency and get the best entry price possible.

Step 3: Trade EntriesSo far we have discussed what we were looking for and watching out for but now we are going to go over the actual placing of a trade. We have been patient and allowed the markets to travel at least 40+ pips away from the session open price. We have had a good retracement of 15 or more pips and a new high or low to confi rm our trend for the session. The next thing to do is simply place our trade.

So where do we enter? Again we want to minimise our risk as much as possible so we wait for a good reversal after the confi rmer peaks at its high or low (depending on the direction we are trading). Ideally we like to see 20-30 per cent retracement of the session travel. So if we have travelled 100 pips in the session and retrace 20-30 pips then this would be a great entry in the direction of the trend (not the direction of the retracement).

A good indicator to use when looking for an entry is the way your correlating charts are moving. If for example the GBPUSD is moving quicker than the EURUSD, we have a retracement on both pairs but the GBPUSD quickly shoots back towards the session high for example, then which currency do we enter? Do we panic and try and get in the GBPUSD on its upward move, or do we simply just go with its correlating partner at the bottom of its retracement, getting a much safer, lower risk, entry price?

We do not really mind what currency pair we trade, we adopt the same strategy to them all. It is all about limiting the risk and getting the best entry as close to risk free as possible.

Now as Figure 3 develops you can see we keep trending, so your decision as a trader is as follows. Do you become a target profi t trader, i.e. when your trade reaches 20 or 30 pips you cash out or do you become a chart trader and base your exits on what is happening around you?

Personally I am a target trader; I look for 20-40 pips as this is what I feel our strategy generally produces. In the example above I would bank out, wait for the next retracement, re-enter, cash out, re-enter, cash out and so on.

Entry times are crucial because the markets are

F3) Entry

This chart shows how we wait for the fi rst two hours of the session to develop. We then wait for our fi rst good retracement of 15 or so pips and a new low to confi rm the trend. We then have another great retracement of 46 pips which was our fi rst sell position. Remember the reversal levels for our trades are 60 pips, so our risk on this particular trade was only 14 pips.


F2) GBPUSD/EURUSD and USDCHF/USDCAD

This shows the relationship between the GBPUSD and EURUSD and the USDCHFand USDCAD. When one major currency is gaining on the USD then it often pulls the other majors with it, EURUSD and if the USD is getting weaker against these currencies then it would only make sense that the currencies such as the USDCHF and USDCAD will move in the opposite direction.


42



very heavily infl uenced by the different sessions and entry of the different volumes of traders around the world. Therefore along with waiting at least two hours at the start we also follow the below guidelines for when we do and do not place trades.

Starting with the European session and in GMT time zone:

• 7am-9am GMT: development time

• 9am-12 noon GMT: trading time• 12 noon to 2pm GMT:

development time, we have the US volume fl uctuate in

• 2pm to 4:30pm GMT: trading time

• 4:30pm-5/5:30pm GMT: European session leaves the market which could cause a retracement or reversal

• 5/5:30pm-10pm GMT: trading time

• 10pm-1am GMT: development time

• 1am-7am GMT: trading time

During development times we ideally want to be out of all intraday trading positions, excluding the end of the US session when we may have maximum price movement (we will get back to this later on).

Step 4: Our StopsWhen we trade we should always place a stop. Many factors could change the trend in a second and

if we do not protect ourselves we could have total account wipe out.

We believe that 60 pips is the reversal level for a currency so ideally if we get a retracement of 30 pips, we then place our stops at the reversal level, 60 pips from the session high or low, 30 pips from our entry. So we are risking 30 pips and the basis of our entry is that we will continue trending and therefore try and break a new session high or low, hopefully giving us a minimum of 30 pips profi t.

As our trade goes in to profi t we should also start to move our stop towards our entry price to limit our risk even more. A good method would be to move the stop ten, however sometimes we need to let the currency breath a bit, so weigh the session volatility up and maybe adopt, move 20 move stop ten.

Step 5: News Event TradingWe have news almost everyday that impacts the markets. This is a very important, yet overlooked topic by a high percentage of traders. We must all trade with an economic calendar open, we must know when the events are coming up. So how do we trade the news? Well basically we do

not, we avoid if possible having any intraday positions on during a news event and we will ideally wait 30 minutes after a news event to see if the trend is going to continue the way it was or change. If we have a position on

leading up to a big news event, ideally we would like to get out, the 15-30 minutes leading up to the news bulletin tend to go quiet and fl at anyway so if you are in profi t bank it. It is always a lot better to bank the profi t and wait for the next setup, than to see a winner turn into a loser. If you are in a losing position, then make sure you have your stop in and ride the news, or you could take the loss. This is what separates traders, crucial decisions like this, but they need to be made, and only you can make them.

We must practice extreme caution when we have medium and high impact news coming out, and many traders do not, and unfortunately get burnt. Protecting the account is goal number one, making money is goal number two.

Step 6: Maximum Price MovementIn any one session or day we believe and have been proven over many years certain currencies will only travel so far before hitting their maximum price movement.

The GBPUSD moves approximately 200-220 pips, the EURUSD, AUDUSD and most other majors 180-200. Therefore we have to be careful taking entries around these fi gures, as basically there is no

more room for them to travel.However, we can and do take

advantage of these days/sessions. As we have said before at the end of a session, or the end of the US session/trading day for most, we normally get a small retracement or reversal when we have a maximum price movement for the day. For example we have passed 10pm GMT, the close of the US session and stock markets, and we have travelled 220 pips, we are therefore more than likely to get a small retracement of at least 20 pips. In this situation we would wait a bit for the close of the session to settle down, then place a sell order for example if we had travelled long 220 pips that session or day. These are very low risk trades as the volatility drops and we would be looking for 20 pips or so.

ConclusionIn conclusion then, we wait two hours at the beginning of every session, known as development time. We like the currency to move away from the session open price at least 35-40 pips. After two hours we wait for a retracement of 15-20 pips and then a new high or low (depending on the direction of trend) to confi rm that this is actually the trend for the session. Once this has been confi rmed we then wait for the next retracement for our fi rst entry. We have reversal levels at 60 pips so ideally we like to have at least a 30 pip retracement, limiting our risk to 30 pips. Sometimes this is not possible but we would always look for a minimum retracement of 15-20 pips. Once we enter the trade we then ride the trade back down and through the session high or low, banking our pips at the bottom or top and then waiting for the next setup. Remember, we always have to consider how far the currencies have travelled for that session or day to make sure we are not entering a trade near to a maximum price movement and therefore seeing the trade go fl at or even worse, turn on us.

Protecting the account is goal no. 1, making money is goal no. 2

43



Trading those Big Gaps

The Retracement at the OpenThe financial markets rarely act in a manner that the average person on the street thinks they are going to act. It is that basic premise which catalysed me to come up with this strategy a number of years ago. I always tell people when it comes to the markets, think of someone you know – either a family member or a friend – who knows nothing about the markets, and before you pull the trigger on a trade, ask yourself if “so and so” would place this order. Whether the answer is “yes” or “no,” the point is to do the opposite. How many times have you seen an economic report get released and markets react in the opposite manner than you expected? How many times has a company reported earnings and the stock performed in an opposite manner than you expected? Now, many times there are explainable reasons for this occurring, such as the news already being factored in thereby making the news or data anti-climactic. Nonetheless, the point is, we as trader s need to have an edge over the competition and sometimes we need to be quick on the trigger and have the courage to step out and do something which the general public would find foolish.

The Set-upHere’s the basic idea behind this strategy: Look for stocks which are gapping either up or down in the pre-market anywhere from 25-30+ per cent. The greater the gap, the greater the potential for a stronger reversal after the market opens. Heresy? No, as a matter of fact, it makes perfect sense. For example, if XYZ announces horrible earnings or the FDA is dragging their feet regarding approval of a drug, and the stock is gapping down 30 per cent in the pre-market, what would you be looking to do after the market opens? If you answered “go long,” then you are getting the idea behind this strategy. What if the stock is gapping up by about 30 per cent in the pre-market, which direction would you be looking to go at the open? That’s right – short.

Allow me to elaborate: If you said to the average trader on the street that XYZ just announced horrible earnings and is gapping down 30 per cent in the pre-market, which direction do you think it will go once the market opens? Why, the average person would respond, “Down, of course”. But you see, we do not

want to think like the average person on the street. We are pros with an edge. Certainly, right at the market open, that stock may continue in the direction of the gap and go down, but there is also the possibility that it may actually turn the opposite direction – if not but for a short period of time. It is not guaranteed to reverse its position, but there is a chance that it could. So there are certain things we will look for to give us an indication that it may reverse, and prepare to get in and out in a relatively short period of time – sometimes in just a matter of minutes.

Here are the tools you will need: obviously, a real-time data feed; one-, three- and fi ve-minute charts; a volume indicator on your charts and Level II. You could add the ADX or perhaps even stochastics, but this strategy is generally so fast, you need to simply focus on the reversal, set your stop, and exit into the strength of the move (I will expand on that in a moment).

What I have found through the years, is that stocks may potentially reverse their initial move shortly after the market

44



open – especially if there has been a dramatic gap pre-market. So, let’s review: if the stock is gapping down – we are looking to go long – if the stock is gapping up – we are looking to go short. Got it?

How Do You Find the Gapping Stocks?First of all, how do we fi nd stocks gapping up or down in the pre-market? Initially, I discovered this strategy by simply watching the fi nancial news in the morning and observing the ticker at the bottom in the pre-market to see if any stocks were gapping either up or down. For example, if I saw a stock was trading at 42 and it was up twelve points in the pre-market (meaning that it closed the previous session at 30), then I would conclude that since this gap was so signifi cant there was a chance it could reverse at the open. It does not mean that I will automatically trade it, it simply means that I will jot it down as a potential candidate. My big concern when a stock is gapping up dramatically is fi nding out whether the company may be getting bought out by another company. Here is what I mean: If XYZ has made an offer to buy ABC at 42 and the stock is indicating to open around 42, there is a good chance when the stock begins trading that it will simply trade around 42 and not


Eric Waddell

Eric Waddell has been trading

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He has developed various

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reverse very much. That is not guaranteed to happen, but since trading is all about odds, the odds are that it will not reverse enough to consider it. So, one of the things to do is always check the news when a stock is gapping up considerably – just to make sure it is not being purchased.

The Rules of the GameThe basic rules are: • Identify stocks gapping up or down in the pre-market 25-30+

per cent. If the stock is gapping up check the news to ensure there has not been a bid to purchase the company. You can fi nd the pre-market gaps on the ticker with CNBC or NASDAQ.com. Begin your research about 30 minutes or so prior to the market open.

• Even though this strategy has worked for stocks under $5 per share, try to stick with stocks in at least the $10 per share range as they tend to have stronger reversals.

• Make sure your candidate has averaged at least 750,000

shares per day over the last ten sessions. This will help ensure liquidity.

• When the market opens, observe your one-, three- and fi ve-minute charts – focusing on your one-minute chart and look for the stock to begin to move in the opposite direction of the gap.

F1) Amylin (AMLN) 1-Minute Showing Gap Down

F2) AMLN Continued Gaining

AMLN opens the following day at $9.83, traded as low as $9.51 during the fi rst minute of the trading day and then traded at $10.20 just eight minutes later for a gain of +7%.

Source: www.tradestation.com

Later in the session, AMLN reaches a high of $11.75, a +23% gain from that initial low at the open.


45



• Look at your Level II to see if there is a “build-up” on the bid or ask – depending on which way you are looking to go. For example, if you are looking to go long, make sure the bid appears to be stronger than the ask.

• When you have “all systems go”, enter the trade with small size. Remember, this is a very risky strategy – not for the faint of heart.

• Set a catastrophic stop. In other words, worst case, how much are you willing to risk on this trade? If you go long 400 shares and set a stop one point away, are you willing to risk $400 on this trade? You must place a stop – this is key. You must focus on your risk and mitigate your downside…remember, you are going against the prevailing trend – if only for a short period of time.

• Exit into the strength or let your stop take you out. You want to exit this trade when the getting out is good. You want to sell when there are ample buyers and buy to cover when there are ample sellers. Do not get greedy with this strategy and try to get an extra few pennies – it will wind up biting you.

• If the strategy has not worked out by 9:35 am Eastern Time, close it out and move on…chances are it will not work out today.

Recent ExamplesAll right, let’s look at a couple of recent examples to better illustrate exactly what we are trying to accomplish:

On Wednesday, October 20, 2010, two bio-tech companies were affected by FDA decisions: Amylin (AMLN) and Alkermes (ALKS). In the pre-market, AMLN was trading down nearly 50 per cent and ALKS was trading down nearly 30 percent. Both stocks met our volume average and were trading around $10. What made these two candidates even more appealing is that they had several things going in their favour for these trades to work out:

1) The gaps were great – especially on AMLN.

2) They both were trading near $10, which if you know about one of my other strategies, $10 per share represents psychological support and resistance; so both were trading pre-market near psychological support.

3) The overall market, these two stocks notwithstanding, was actually indicating higher – which could help drive both of these stocks higher and obviously help with our retracements.

So, all of these things converged to give us an indication that this strategy was

going to work. As you can see from the one-minute charts on both of these stocks – right after the open, they reversed. Along with a strong bid on the Level II as confi rmation, we quickly place the trade to enter at the market. If you attempt to specify your own entry price with a limit order, you run the risk of not getting fi lled – as this may move too quickly. With our stop in place, there actually was ample opportunity to exit into the strength and call it a day – in just a matter of minutes.

ConclusionI cannot emphasise this enough: this is a very risky strategy. It does not always work out as perfectly as our examples. With that in mind, and the fact that as traders we are always focusing on our risk, it is imperative that you always set a stop! There are no exceptions and always try to exit into the strength – do not get greedy! This strategy can provide very quick profi ts, but if you are not diligent about controlling your risk (small size and placing a stop), it can go against you in a hurry and damage your equity. Stick to the rules – I came up with these through trial and error – there is a reason for them. Good luck and good trading!

F3) Alkermes (ALKS) 1-Minute Showing Gap Down

ALKS opens at $10.30, trades as low as $9.85 and then reverses to $10.75- a 9+% gain within 20 minutes.


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Trading Dead Cat Bounces

A Guide to Picking Stock Market Winners – Part 1During the credit crunch, I once mentioned on the BBC my opinion that a rally in the market was a dead cat bounce. This of course meant that the strong and sudden rise was purely a technical reaction caused by a very steep fall. The phrase comes from the American joke that even a dead cat bounces if you drop it from a high enough place. The presenter quickly made sure the listeners understood. She said: “the BBC of course does not condone cruelty against animals.”

48


TRADERS´ BASICS

Dead Cat Bounces and Catching Falling KnivesHow can you trade the dead cat bounce? Should you even try? The dead cat bounce is what every trader wants to capture when they see a share plummet, but are they going to catch a falling knife instead? When you buy books on trading or go to courses you will undoubtedly be regaled by trading rules. You will be told that you must do this and must not do that. These rules are generally meant to save you money rather than make you money. Rules to save you money seem on the face of it sensible. Who wants to lose money after all?

The classic piece of advice is: do not catch a falling knife. We get the idea clearly. Do not try and buy a share which is falling sharply, because it will fall more and you will get hurt. We get the image of a sliced hand and the sharp falling blade; it’s a compelling piece of advice. It is a trading law but wait. If you save yourself from losses with this technique, by fl ipping it around you should make money.

TRADERS´ BASICS

The market has symmetry: what can predictably lose you money should, if you do the opposite, make you profi ts.

If buying a sharply falling share will lose you money, then all you need to do is sell it and you will make money for sure. If you sell falling knives, according to the rule, you should make lots of money. So why isn’t this advice given? It is not given because it will not make you money. So, if it does not make you money why is it bad to buy a falling knife?

50/50 Outcomes A serious trader will have taken lots of data and crunched it through a spreadsheet. They will have found that, roughly speaking, trading ideas create 50/50 outcomes. As such you can catch a falling knife and you can make money half the time and the other half you will fail and lose. If you dig further you will fi nd the money you win and lose will be roughly the same and that your costs of trading is where the real loss comes from not the likelihood of success or failure of the idea itself. This revelation

F1) Connaugh

This company went spectacularly bust. The fi nal giant slump before inevitable demise neatly shows the dead cat bounce effect. Here it is intraday. For those brave enough to stick their neck out there was a 100% profi t to be made in hours.

Source: www.advfn.com

Clem Chamber

Clem Chambers is CEO of

ADVFN, a fi nancial market

website (www.advfn.com).

F2) De la Rue

Bad news all round for this blue chip. You can see the dead cat bounce but it comes in late. If you had got in the second day after the fall you would have still made a profi t if you had got out quickly on the eventual jump.


49


TRADERS´ BASICS

they often suffer sudden dramatic unexpected bad news. The ineffi ciency of their news fl ow opens up opportunities.

Temporal ineffi ciencies are also quite common and a good example of one is the opening and closing period of market trading. The trader looks to trade open and close because they are time-constrained periods where price equilibrium has not been reached. So is a falling knife an ineffi cient period of market action? If you examine the chart you can see that it is.

For starters the price of a stock does not hit its destination instantly. The price travels to its destination. This is especially apparent if the news is during the trading day. In a perfectly effi cient market it would hit the right price instantly and do none of the thrashing about we see. The price then will often be very volatile over seconds, minutes, hours and days. There will be several dead cat bounces. The trick is to buy the big one.

In Practice Firstly let us stick to proper companies, not wild speculative shares, just blue chips with a signifi cant market cap. Even a big stock which has had bad news will fall a lot. The scale of this fall will often be a function of the overall market. You can benchmark this over time. In a

goes for pretty much all the mechanical trading ideas you can come up with. This is a function of the random walk or if you want to look at it another way, the law of pre-emption.

The law of pre-emption says that if there is an opportunity in the data to be exploited, there will be enough people grabbing at the opportunity, each in turn at an ever lower rate of return, to grind the opportunity away to zero. This grinding is what creates the effi cient market. It is the eager traders chasing a profi t that creates the very random walk they all disbelieve exists and hate the idea of. This 50/50 effi cient market is what makes the markets work. Meanwhile the trader is looking for the 51/49 win/lose opportunity or better still the 80/20 opportunity to make his profi ts from. Where will they fi nd it?

Ineffi ciency Is Your Friend This has to come from ineffi ciency: either market-wide, instrument-specifi c or temporally-based. The ineffi ciency we crave is a market-wide ineffi ciency; say a market with weak liquidity. An ineffi cient market could be a trader’s paradise, but sadly there won’t be much action to be had in a market with little fl ow to be traded.

Instrument-specifi c ineffi ciencies can exist; mining shares are a good example as

terrible bear market it will be 40 per cent in a normal market 20 per cent and in a bull 5-10 per cent. The price will then perform again in line with the market conditions. It will get its dead cat bounce strongly one to four days later on the open. Once you follow the dead cat bounce theme you will have a pretty good idea of when and how much a big cap will perform through a cycle of ‘falling knife’ and ‘dead cat bounce.’

You see from a list of ‘Biggest Fallers,’ a big cap company getting pounded on news. You follow it for the next week or so and you will see the pattern. After three of four examples you will be able to catch the bounce and exit. Once the bounce is over, you want to be out. The stock can go way up or slump down again, but you are trying to profi t from the short-term ineffi ciency of the news-led trauma; not the medium- or long-term prospects.

Conclusion It is perhaps because the law says not to try and catch a falling knife and not to try and capture the dead cat bounce that there is opportunity there. As no one dares to look for advantage, there’s a large ineffi ciency to be captured.

F3) Gartmore

A dead cat bounce you could have caught in two places; intraday on the second day or by buying at the close of the second day for the next open. Over the last few months the dead cat bounce tends to occur on the second day after such a crash, but that timing will mutate with market conditions.


Infobox

All articles of Clem Chamber’s article series can be found in his book “101 Ways to Pick Stock Market Winners” which will be published on 24th February 2011 by Beautiful Books. Paperback. Price: £6.99.

Infobox

All articles of Clem Chamber’s article series can be found in his book “101 Ways to Pick Stock Market Winners” which will be published on 24th February 2011 by Beautiful Books. Paperback. Price: £6.99.

Trust Only the Market Itself

Perceived Value Versus Real ValueWhen I was in the sixth grade, I came home from school beaming with pride. I found out that day that my Joe Montana rookie card was worth $180 in the newest edition of the football price guide. I ran home to tell my mother and promptly asked her for the $180. My mom laughed at me and told me that my card was not worth that much money. She explained further that it was only worth what someone was willing to pay me for it. She took me to the hobby store where the owner paid me $90 for the card, which quickly taught me a lesson in perceived value versus real value.

51


TRADERS´ BASICSTRADERS´ BASICS

True ValueAs traders, we have to overcome the constant barrage of news and opinions about the true value of a company as it relates to our trading decisions. The lesson that I learned as a child was a telling one: something is worth what someone will pay for it and nothing more. Individual traders and investors are told by the fi nancial community that the markets are complex and that only the professionals can understand them. If traders thought about buying and selling securities in the same way they buy and sell everything else in life, some of the mystery can be uncovered.

Earnings ReportsMuch of the confusion in the market originates from the barrage of earnings reports, economic reports, analyst

Chuck Fulkerson

Chuck began his trading career

in 2006, primarily focusing on

the options arena and became

profi cient enough in trading

through the use of options that

he was able to leave his former

career to focus on mastering

the fi nancial markets. Chuck

graduated from California

University of Pennsylvania with

a degree in computer science

in 2000. Chuck has hosted

trading radio programs and was

a speaker at the International

Money Show in 2009.

estimates, and, of course, the hype and news of mass media. The fi rst example is from looking at earnings reports. Just because a company has poor earnings does not mean its stock price is going to fall. Conversely, just because a company has blow out earnings does not mean that the stock price will rise. A great example of this is AAPL and their October 2010 earnings. The October results were $4.64 per share against an earnings estimate of $4.08. Even more impressive than the earnings beating estimates was the fact that the 2009 quarter-over-quarter comparison was up from $1.82 per share to $4.64 per share. Those excellent earnings numbers would drive most traders and investors to assume and position themselves for a jump in price and a great

F1) Apple (AAPL) After Earnings

AAPL reported earnings after the bell on 10/18 and had seller earnings, beating estimates and improving year over year. Common perceptions would lead one the belive that after such strong earnings the stock would gap up, however there was a gap down of 14.82, or 4.8%.


52


TRADERS´ BASICS

lead to a gap or major move in the US equities markets. Much like earnings reports, economic reports are best used when the announcement moves the market or security into an area where there are willing buyers or sellers. Due to the unpredictability of most important market movements, it may be best to avoid the market and not assume new positions until after the announcement is released. Once the announcement is released and the market has time to digest the move, regardless of the actual results, then it is safer to enter a trade.

AnalystsAnother piece of the skewed perceptions of traders come from the mouths of analysts. Analysts take the current value of a company into account, along with the projected growth and earnings of a company to issue buy, sell, and hold recommendations. They look at the fi nancial results, market prices, and industry factors that might affect the price of a company‘s stock. The problem, especially for traders, with most analysts is that their information is totally based on the perceived “book value” of a company. A good example of this is Bank of America (BAC). BAC as displayed here in a weekly chart has been in a distinct downtrend since

long trading opportunity. In reality, the stock gapped down almost $18.00 into an area where buyers thought there was a strong buying opportunity. The perception that the stock would do well based on good earnings was trumped by the supply and demand of the individual security. The reality was that the stock gapped down to around $300, where there was a variety of buyers that were interested in buying the stock and causing its price to rally.

Economic ReportsEconomic reports can be just as confusing for traders. One of the behavioural pitfalls for traders is ignoring the results of the report and only focusing on the reaction of the market to the announcement. The best part about economic reports and announcements is that they are regularly scheduled, and most of the results are anticipated. The biggest frustration for traders is when in the midst of an apparently positive economic report the markets still fall. There are examples too numerous to pick only one scenario representing this situation. Most of the major, market-moving reports come out at 8:30 am EST and move the Futures and Currency markets. The movement in the Futures and Forex markets will often

late 2006. In the years spanning 2006 – 2010, there have been 36 analysts opinions released, only one of which was a sell rating and two of which were underperform ratings. All of the rest of the analyst ratings were either hold the stock, buy the stock, or to rate it an outperforming security. The perception of the analysts is not as important as the distinct downtrend presented by the stock.

Conclusion As a trader that trades reality, it is much better to believe in price than the perceptions of the analysts or to try and anticipate a stock’s price from a news announcement. Many traders spend so much time trying to anticipate the way the market may move on an announcement that they speculate before an announcement is reached. As a good trader, instead of speculative guessing based on the opinions of others, we should focus on increasing our probability through the study of price action and changes in price over time. As a sixth grader, I learned an important fi nancial lesson from Joe Montana; it just took me another 20 years to put it to good use.

F2) Bank of America (BAC) Weekly Chart

Since December of 2006 there have been 36 analyst reviews of BAC. Of the 36 there has only been one sell rating and two underperform rating.


53


Money Management Is Key

Thomas Stridsman is well known as a designer of trading systems. He has many years of experience in the industry. For example, he worked at Rotella Capital and CQG. Today, Thomas is working at Alfakraft Fonder where he manages two funds, ALFA Energy and ALFA Commodity. Thomas is co-owner of the business and the head portfolio manager. He also holds a CTA (Commodity Trading Advisor) license, which makes it possible for the company to manage individual accounts for American investors, who otherwise might be excluded from investing in the funds. Thomas has written two books, “Trading Systems that Work” (2000) and “Trading Systems and Money Management” (2003).

Thomas Stridsman


54


TRADERS´ PEOPLE

I am trading this strategy in a managed account for now, with very good results over the last several months. Inception date was 1 June 2010. The fi gures refer to performance after management fees.

Source: www.alfakraft.se

T2) Performance Commodity Futures Fund

macro-economic climate. I have worked hard on systematising this process, incorporating a few macro-economic variables, such as trends in infl ation, currencies, interest rates, as well as world equity indexes into my position-sizing algorithm. For example, consider currencies and interest rates, right now, with these exceptionally low short-term interest rates, the trends in the currency markets tell me to make all long trades in all markets approximately 25 percent larger than all short trades in all markets, given a target return on a client account of around 20 per cent. If, for example, the interest rate increased to four per cent and the currency trends reversed themselves, then I would

ALFA Commodity Fund

19/11/2010 (estimated) 0.22 %October 4.51 %September 7.91 %August 2.79 %July 2.01 %June 0.68 %

Performance since start (01/06/2010) 19.32 %

This table shows my performance in Forex on a monthly basis up until October 25. You can also see yearly totals for Barclay’s FX index (BFX) and the S&P 500 up until September.

T1) Forex Performance

F1) Forex Performance Chart

This graphic shows my performance listed in Table 1.

Source: TRADERS´ graphic, MS Excel

TRADERS : Thomas, we last interviewed you about three years ago for TRADERS´ magazine. Please tell us about your projects within the last three years. How have things devel-oped so far?Thomas Stridsman: Right now things are moving along nicely. I have traded the FX markets for a few years now, with reasonable results, beating Barclay’s FX index (Table 1). You can see my performance in Figure 1. Just recently, My partners at Alfakraft and I have set up an energy-futures fund. We also have a more diversifi ed systematic commodity-futures fund in the works, which I am trading as a managed account for now, with very good results over the last several months (Table 2).

TRADERS : What about your research?Thomas Stridsman: Research wise I have made some great discoveries which I am slowly but surely incorporating into my trading. Mostly this has to do with position sizing and money management.

TRADERS : Could you please describe these discoveries in detail?Thomas Stridsman: You have probably seen or heard of many systematic traders using the term, “discretionary overlay”. Usually this means that they allow themselves to alter the position size given by the system, depending on their personal opinion about the current

Monthly Performance (%) (in USD)Year Total Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec BFX S&P 5002008 11.64 0.00 3.07 2.68 -1.16 -0.95 7.75 3.50 -38.5

2009 10.05 -2.01 2.41 3.64 1.49 11.54 -4.30 0.97 -2.36 0.97 -3.27 -0.29 1.73 0.91 23.452010 12.75 -1.80 -0.89 -3.54 -1.08 3.39 -0.25 7.27 -0.32 7.13 2.77 3.02 4.50Total 38.52 Total 7.60 -20.6

Annual 11.47 Annual 2.47 -7.40

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TRADERS´ PEOPLE

have to make all short trades approximately 30 per cent larger than all long trades. Overall, this process reduces the risks while making the systems more adaptive to the current economic environment. I think this is a very unique feature of our systems, which we believe will result in a big competitive advantage.

TRADERS : How are these concepts implemented in practical trading?Thomas Stridsman: This will not alter when to enter and exit trades, so there is no use in showing any entry and exit charts. Instead, the most obvious difference is that you get a larger size difference between your long trades and short trades depending on what the macro-economic variables are telling you. This will result in smoother, steadier equity growth. Let me show you two charts of how this can affect the equity growth of an account. The fi rst chart (Figure 2) shows the performance of a long-term breakout system without this money management. The second chart (Figure 3) shows the performance of the same system with my new money management algorithm. The average risk per trade is about the same for both versions, or slightly less for the improved system. Notice how the fi nal equity is approximately the same in both charts, but how the

equity growth is much smoother and steadier in the second chart. This has nothing to do with where and when to enter and exit, but only with how many contracts to buy and sell. In my experience, knowing how large to trade is much more important than knowing when to trade.

One additional benefi t is that this algorithm has no parameters to optimise. It is totally adaptive in real time, which actually makes the complete strategy (system for entry and exit, plus money management) more robust and reliable, despite the additional math going into the algorithms.

Building trend-following systems that perform reasonably well is easy. Making your strategy competitive relative other good trend-following fund managers is the really hard part. This has everything to do with money management and very little to do with when you enter and exit a trade.

TRADERS : What about well-known techniques based on optimal f? Could you briefl y explain the optimal f technique as well as the advantages and disadvantages?Thomas Stridsman: First of all, the theory behind optimal f lies at the bottom of everything I do. What I just talked about, you could describe as optimal f with additional constraints. The

concept of optimal f is highly misunderstood among many traders, even the professionals. When Ralph Vince introduced the concept he basically defi ned the term “optimal” as making as much money as possible over the period tested or traded. The term “f” refers to the fraction of your equity to risk, for example half a per cent or two per cent. He did not consider the path the equity growth could take in terms of drawdowns and run ups. In fact, he pointed out that the better the system, the higher the optimal f, the larger the drawdowns will be – larger, not smaller – on its path to its maximum fi nal equity. So, if you trade two systems at their respective optimal f’s, the better system – the one with the higher f – will likely produce larger drawdowns than the worse system.

Most good managers, who deliver 15-20 per cent per year could, if they wanted to, crank up the risks and trade sizes of their systems quite a bit and keep increasing both the absolute returns as well as the risk adjusted return (the Sharpe ratio). In reality what is holding them back are the one-time (or occasional) worst case scenarios of 16-20 per cent drawdowns or more, because this drawdown limitation is dictated by how much their clients, who do not understand this math, can

This chart shows the performance of a long-term breakout system without my specifi c money management.

Source: Trading Blox

F3) Equity with Specifi c Money Management

This chart shows the performance of the same system as in Figure 2 with my new money management algorithm. The average risk per trade is about the same for both versions, or slightly less for the improved system. Notice how the fi nal equity is approximately the same in both charts, but how the equity growth is much smoother and steadier in Figure 3. This has nothing to do with where and when to enter and exit, but only with how many contracts to buy and sell. In my experience, knowing how large to trade is much more important than knowing when to trade.

Source: Trading Blox

F2) Equity without Specifi c Money Management

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TRADERS´ PEOPLE

stomach before they withdraw their money. Thus, limiting your worst-case drawdowns below these levels will result in what actually are suboptimal risk adjusted returns. In this case, the manager does not try to optimise returns. Instead, he aims to optimise customer satisfaction. This is why you see many trend-following CTAs delivering returns in the 15-20 area, with worst drawdown around 16 per cent and Sharpe ratios around or slightly below 1. They are optimizing customer satisfaction by applying regular optimal f theory with a few additional constraints. If you are your own customer you can optimise your trade size relative to whatever you decide, defi ning the term “optimal” that makes the most sense to you. It does not have to mean fastest possible equity growth.

TRADERS : How did system trading change in general during the years (and decades)?Thomas Stridsman: I could answer that in two parts. First, for longer-term strategies things have not changed that much as far as I can see, in terms of fi nding good systems for entry and exit. In terms of money management, however, there is still much work to do and methods to be implemented. I have done some

good work myself and I think I can tell from the track record of other CTAs who might have come to similar solutions as myself as well as some who have not.

Second, in terms of shorter term strategies things have changed a lot obviously. I am thinking here of high-frequency trading (HFT) and the many ways we have seen such strategies implemented over the years.

TRADERS : Do you see any implications of high andsuddenly developing volatility, which went extreme on 6 May for example? This might be a problem to solve even for long-term strategies as stops might be affected in the worst possible way.Thomas Stridsman: Not really. Stops might or might not be affected in the worst possible way. There is no way to tell from one scenario to the next. One has to understand that there will always be times when certain systems just do not perform that well and suffer through those times. There is no way round that. Using the optimal f concepts together with the other risk-limiting ideas I just talked about should give you confi dence to take the drawdowns, knowing that after rain comes shine and your systems will start performing well again. I almost said the systems should start performing

as “they should” again, but that would be wrong because they should not and will not be profi table at all times. That is just so. There is no way around that. No one can cover all his bases and as a trader you need to come to grips with that thought.

TRADERS : What is the role of High Frequency Trading (HFT) Algorithms?Thomas Stridsman: Well, I do not pretend to be a high-frequency expert by any means. But obviously the impact from this type of trading has been huge. Just think of the fl ash crash back in May this year. My personal point of view is that HFT has been taken too far and I would not be surprised if the exchanges and the fi nancial authorities start to regulate it much harder over the next several years. The way I see it, most of it really does not add any long-term socio-economic value to the marketplace. But that is just my personal opinion.

If anything, as a trend follower I am not spending too much time trading my way in and out of a position. I more or less buy or sell at market, as my orders, which rest with my broker, get hit. Over the long-term and on average, HFT and quote stuffi ng should help me as it should make the bid-ask spread smaller, which would limit my slippage.

57

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58


TRADERS´ PEOPLE

TRADERS : What are the main challenges when developing a trading system and how do you approach these issues?Thomas Stridsman: In terms of fi nding good entries and exits not much has changed as far as I am concerned. The main challenge lies within the developer himself. Do not curve fi t. Keep it as simple as possible and your strategy is the most likely to work in the future as it did in the past.

TRADERS : There are many pre-defi ned trading systems available, including a “great looking and steep track record”. However, usually these systems only work in-sample… Is there anybody you can trust when buying a pre-defi ned trading system?Thomas Stridsman: Ha ha, yes, you can trust me, had my systems been for sale. No, seriously, the true answer is yes – and no. You should not trust anybody but yourself. Develop your own strategies if you are in a position to do so. Otherwise, talk to a good broker specialising in tracking and executing trading systems, which they will help you to lease from the developers. I personally work closely with a broker in Chicago. They do not let you lease my stuff, but I trade through them and they help me monitor my positions so I can step away from my computer.

Another good choice is Attain Capital, another Chicago based broker, which I currently do not use.

TRADERS : What are the “must-haves” when it comes to a trading system – in other words, what elements would you like to see in order to put your own money into it?Thomas Stridsman: Steady equity growth, drawdowns that would make sense from a macro-economic point of view and that could be suffi ciently explained by the developer. Sharpe ratios of at least one or slightly higher, but too high Sharpe ratios probably mean you are curve fi tting. Exactly how is too high is diffi cult to say and has to be judged on a case-by-case basis.

TRADERS : What does your personal trading strategy look like?Thomas Stridsman: Well, I think I already have described the money management in as much detail as I can without saying too much. As far as where and when to enter and exit, let us just say I strive to keep things as simple as possible. To spell it out, all my systems are more or less ordinary three-phase breakout systems, meaning they can be either long, short or fl at. I currently use three different systems, each one based on a standard technique

such as lowest-low / highest-high crossovers or Bollinger bands, nothing fancy. For each system there are no differences in regards to the parameters for when to enter long and short trades. The only thing that could differ between long and short trades is the size.

For trailing stops I use either moving averages, moving medians or centre lines. As I have stressed so many times already, the systems is not the secret, the money management is.

I am showing you the two charts of my last eight to ten trades in silver for two of the systems (Figures 4 and 5). Please count how many losing trades it took, within the long consolidation area, and multiply those losers by two, because I took losers on the short side as well, before I jumped on the two big winners I am currently riding. Also note how much of the open profi t I am giving away before the systems let me exit the winner. This is what trend-following is all about. You lose, lose, lose and lose some more, and then – BAM! – one big winner makes up for it all and adds you the profi ts. But as if losing fi ve, ten, 15 times in a row was not enough, even your winning trades end up losing. This is trend-following. You need to be comfortable with that or go do something else…

F4) Many Small Losers and Finally a Big Winner

The system underlying this chart (silver) is based on a regular highest-high / lowest-low trading idea. There is no way around the fact that you will have to suffer through many losing trades as a trend-following trader, but in the end your patience will be rewarded.

Source: Traders Studio, CSI Unfair Advantage

F5) Another System for Silver

The system underlying this chart (silver) is based on the common concept of Bollinger volatility bands.

Source: Traders Studio, CSI Unfair Advantage

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TRADERS´ PEOPLE

TRADERS : What markets are you most active in?Thomas Stridsman: I am equally active in all markets in a broad and well balanced portfolio. It is all up to the systems to generate the signals for me. I do not care where and when they pop up. In the broad commodity fund I track over 40 markets, subdivided into seven sectors (currencies, interest rates, equity indexes, metals, energies, grains and miscellaneous), with approximately the same number of markets in each sector.

TRADERS : Do you use any technical indicators?Thomas Stridsman: You basically do not need any technical indicators for trend following. The ones I use are for my trailing stops, which I just described. As I have already described, my position sizing algorithm considers several macro-economic time series.

TRADERS : Do you also trade strategies other than trend following?Thomas Stridsman: No, and as things are right now, I probably never will. For the two funds I manage right now, we have taken the deliberate decision to use trend following and trend following only. We believe this is in the best interest of our clients.

TRADERS : Any comments on the importance of trading a portfolio of systems as a strategy in contrast to implementing a trading strategy solely for a single issue? In other words, what about diversifying idiosyncratic risk when it comes to portfolio trading?Thomas Stridsman: I do think it is important to trade a portfolio of systems, but not to diversify in the traditional sense. Traditionally diversifying between systems has meant to mix uncorrelated systems of different time frames and logic – long-term trend following with short-term counter trend etc. I do not believe in this. Taken to the extreme what you create is just one huge fl at position so to speak, generating commission income for your broker. The way I prefer to do it is to diversify across several (or at least a couple) different trend-following systems, each complementing the others in catching different portions of the trend.

I like to think of it as two soccer teams. If you throw eleven uncorrelated guys on the pitch,

all running around at random, which they need to do to remain uncorrelated, you might confuse your opponent for a while and score a goal here and there, but ultimately you will lose.

Especially if you are up against a team of eleven highly correlated players, all complementing each other, covering various areas of the pitch in a synchronised fashion. I would much prefer to be the coach of the correlated team.

TRADERS : How many different inputs (indicators) would you recommend using within a trading strategy to get a good fi t?Thomas Stridsman: Strictly speaking and in the best of worlds: One. But to be serious, preferably not more than three to four. Two for entry, two for exit, better still if you can combine them and use the same for entry and exit. Something that I never use is fi lters, such as the popular

ADX indicator, which I believe adds that extra layer of curve fi t which ultimately will make the system fail in the future. If any of my systems need a fi lter, it is a bad system to begin with, as far

as I am concerned. I do believe you can use more indicators, the shorter term your system, but in so doing, frequent re-optimisation of the system should play an important part in the system logic to begin with.

TRADERS : Which indicators are good combinations with each other?Thomas Stridsman: In essence there are only two types of indicators: there are level-type indicators, which are used to isolate cycles. These include moving averages, median lines, centre lines and sometimes even the mode. Then there are volatility and momentum indicators, which I lump together. If you think of it, high momentum is high volatility in one direction. These include standard deviation, percent momentum, mean absolute deviation and High-Low distances, etc. An entry usually combines two indicators, one from each group. Never combine several indicators from the same group. An exit

usually holds one indicator from one of the groups. Again, never use several indicators from the same group.

TRADERS : How do you know if a trading system really works?Thomas Stridsman: This is almost a philosophical question. What do we mean by working. Take last year and the fi rst half of this year, most trend following CTAs were losing money. Did our systems work or not? To answer that we have to understand what our systems are designed to do. They are designed to lose a little in a series of trades, as each system tests the waters so to speak. If the trend does not develop the system will lose a small amount. The systems lost a small amount over this time period because there were hardly any trends. So from that perspective the systems did just fi ne losing money. We have to understand that for something to work and make money is not necessarily the same thing.

So if a system can work and lose money and not work while making money, how do we know if we can trust the system in the future? The answer to that is that we do not trust the system per se, we trust our research. The procedures and methods we use, the stress tests we perform, the ability not to curve fi t, etc.

The concept of optimal fis highly misunderstood

among many traders, even the professionals

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TRADERS´ PEOPLE

TRADERS : How do you make sure to have good (non-garbage) data to backtest your ideas? Are you doing double- or triple-checks with several databases?Thomas Stridsman: Personally I use data from two price data providers, but have found one of them superior and so far I have had no complaints in this regard. I also do not run my signals straight through from my signal generating software to my broker’s orderbook. Instead I have a manual step built into the process where I can double check everything looks ok, before the order is passed on.

TRADERS : In your book “Trading Systems and Money Management” you mention Monte Carlo Analysis and Bootstrapping. Please, can you briefl y explain the basic ideas of these concepts to us and why a system designer should use it?Thomas Stridsman: To be brief, they are both stress-testing and signifi cance testing techniques, based on statistics theory. Be reordering or resampling your trades, or daily or monthly results you can create new equity curves from your original data. The performance of each new equity curve will differ from all the others in terms of average period profi ts, drawdowns, winning periods etc.

By performing statistical analysis on a large number of such equity curves, say 1000 of them, you can fi rst of all decide whether the performance of the original data stream differs signifi cantly from zero. You will also get a better feel for your future average period profi t, max potential drawdown, etc.

I cannot from the top of my head remember the difference in defi nition between Bootstrapping and Monte Carlo. I think in one of them you just randomly alter the sign of the period return, in the other you randomly reorder all period returns. In one you test if your result is signifi cantly different from zero, in the other you apply a confi dence interval around the average return of many samples. I cannot remember which one is which, and I think most analysts use the terms interchangeably. Whenever I need to speak in exact terms I look it up. David Aronson’s book, Evidence-Based Technical Analysis is a good place to start, or the web site www.automated-trading-system.com, a blog run by a guy named Jez Liberty. He does an excellent job in writing about these topics in a simple manner. I think he is very good at breaking down the complex stuff into simple terms. Highly recommended.

TRADERS : From a general point of view, which are the

most important things one needs to consider in order to succeed in systematic trading (e.g. positive expectancy, money management, risk management, psychology, account size, indicators etc.)?Thomas Stridsman: Let me order the ones you mention: First you have psychology, then you have psychology, and then you have some more psychology… Then come positive expectancy, which does not mean that you should expect a positive outcome every day and every trade, but in the long run, that is why you need the psychology fi rst. Account size is also crucial, if you feel (psychologically speaking) you are risking too much per trade given your trading strategy and target returns you probably are and should stop trading or fund your account with more money.

By risk management I mean all risks surrounding your business as a trader. Do you have enough computers and data feeds, robust internet connections, etc. to support your business as a trader? Do you have peace of mind and a good working environment? Are your wife and kids happy? If not, you need to manage this risk or your psychology will get you.

Finally, let us talk system and strategy technicalities. Money management is way more important than where to enter

and exit, which is the one subject on which most people spend most of their time, on which most books are written and on which most gurus make their living, namely the topic of indicators, is the least important topic of them all…

TRADERS : What is your opinion about Neural Networks?Thomas Stridsman: They probably work, although you probably have to be more careful than otherwise regarding garbage in garbage out. They are probably already in heavy use within the HFT world for short-term pattern recognition, but I am only speculating.

TRADERS : Any words about morals and ethics in the world of trading and fi nance, as even quotes are manipulated e.g. for treasuries as the Fed is buying aggressively?Thomas Stridsman: There probably are no moral and ethics in the world of fi nance, but you cannot let that get to you. Watching television it seems to me that he who screams the loudest wins the game, at least in the short term, attracting attention and other people’s money. That said, as long as a price is an actual quote and not a data mishap you have to trust it. What else is there? In regards

to trusting other players, even the Fed. You should not trust anybody. However, you should not necessarily regard them as your opponents or enemies either. They are just small portions of what make up the markets, and you should never fi ght the markets. That is like swimming the river upstream. You will only exhaust yourself getting nowhere. Float downstream, trade the trends, preferably with your own strategies.

TRADERS : What are the best books about trading and Technical Analysis / Quantitative Analysis available today?Thomas Stridsman: If I may, I still think my fi rst book, Trading Systems that Work does the best job in tying together the systems development process with the money management process, but I do not read that many books these days. If there are any other, newer books like my own out there, please let me know. Other than that, Ralph Vince’s latest work is very good, and I also like the work of David Aronson. Trend following by Michael Covel is a great read for inspiration and I will never get tired of Reminiscences of a Stock Operator.

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TRADERS´ TOOLS

SE

MIN

AR

S Date Seminar Firm Location Website30.11.2010 Learn. Trade. Succeed! eSignal Learning UK www.esignallearning.com30.11.2010 Trading Futures with eSignal eSignal Learning USA www.esignallearning.com30.11.2010 A Guide to Long Term Investing with TD Waterhouse TD Waterhouse London www.tdwaterhouse.co.uk30.11.2010 Stock Market Training WIN Investing London www.wininvesting.co.uk01.12.2010 Technical Analysis for beginners with Sandy Jadeja Finspreads London www.fi nspreads.com01.12.2010 Stock Market Training WIN Investing York www.wininvesting.co.uk02.12.2010 Learn. Trade. Succeed! eSignal Learning USA www.esignallearning.com02.12.2010 Trading Integration with eSignal eSignal Learning USA www.esignallearning.com02.12.2010 Stock Market Training WIN Investing Leeds www.wininvesting.co.uk04.12.2010 Upcoming Trading Opportunities Finspreads London www.fi nspreads.com04.12.2010 Trading Options for Greater Profi ts eSignal Learning USA www.esignallearning.com04.12.2010 Trading the World‘s Financial Markets Gann Limited Cheshire www.gann.co.uk04.12.2010 Stock Market Training WIN Investing London www.wininvesting.co.uk06.12.2010 Stock Market Training WIN Investing Reading www.wininvesting.co.uk07.12.2010 Learn. Trade. Succeed! eSignal Learning UK www.esignallearning.com07.12.2010 Trading Forex with eSignal eSignal Learning USA www.esignallearning.com07.12.2010 Stock Market Training WIN Investing London www.wininvesting.co.uk08.12.2010 Using Candlestick Patterns for Short Term Trading Tactics (Account Holders Only) Finspreads London www.fi nspreads.com08.12.2010 Learn. Trade. Succeed! eSignal Learning Singapore www.esignallearning.com09.12.2010 Trading Futures with eSignal eSignal Learning USA www.esignallearning.com09.12.2010 Stock Market Training WIN Investing Richmond www.wininvesting.co.uk10.12.2010 Stock Market Training WIN Investing London www.wininvesting.co.uk13.12.2010 Portfolio Review and Best Practice with Dominic Picarda TD Waterhouse London www.tdwaterhouse.co.uk14.12.2010 Learn. Trade. Succeed! eSignal Learning UK www.esignallearning.com14.12.2010 Trading Stocks with eSignal eSignal Learning USA www.esignallearning.com14.12.2010 Stock Market Training WIN Investing Manchester www.wininvesting.co.uk15.12.2010 Technical Analysis for beginners with Sandy Jadeja Finspreads London www.fi nspreads.com15.12.2010 Stock Market Training WIN Investing Birmingham www.wininvesting.co.uk16.12.2010 Learn. Trade. Succeed! eSignal Learning USA www.esignallearning.com16.12.2010 Trading Forex with eSignal eSignal Learning USA www.esignallearning.com16.12.2010 Trading the World‘s Financial Markets Gann Limited London www.gann.co.uk17.12.2010 Trading Options for Greater Profi ts eSignal Learning USA www.esignallearning.com21.12.2010 Learn. Trade. Succeed! eSignal Learning UK www.esignallearning.com21.12.2010 Trading Options for Greater Profi ts eSignal Learning USA www.esignallearning.com21.12.2010 Trading Integration with eSignal eSignal Learning USA www.esignallearning.com22.12.2010 Learn. Trade. Succeed! eSignal Learning Singapore www.esignallearning.com22.12.2010 Learn. Trade. Succeed! eSignal Learning USA www.esignallearning.com23.12.2010 Trading Stocks with eSignal eSignal Learning USA www.esignallearning.com

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TRADERS´ COLUMN

If you would like to reach a far-off destination by car, you would better put the pedal to the metal. Otherwise you will run the risk of being on the road for so long that you cannot reach your destination any more. And remember this: On the way there lurk innumerable hazards. And the less time you spend on the road, the shorter the period is during which something could happen to you.

Doesn’t that sound reasonable? Driving faster means reaching your destination earlier, which in turn means less time to be exposed to the hazards of road traffi c. No – not that good an idea? You would rather drive a little slower and not get quite as far or not reach your destination until a little later? Why then don’t you do your trading like that? Many traders – whether they are experienced or not – try to trade as fast as possible. That means: small stakes on the 15-minute chart; every day at

least fi ve trades in three markets; automatic order routing to avoid missing a single signal from the trading system; fantasies about the level of the annual

performance. Only 25 per cent? Surely you have heard of better approaches. A millionaire in one year? That sounds more like it. Unsurprisingly,

high-frequency trading is all the rage now. That is where they are fi ghting for each and every tick with huge computers as well as a gigantic investment in infrastructure and execute up to 10,000 trades a week. Invariably at minimum risk and yet fantastic yields with minimum fl uctuations in one’s portfolio. Obviously, this may work – just as it does with a racing driver who needs less time for the same distance than a Sunday driver.

But have another think! Do you seriously believe that you of all people are the Michael Schumacher of the world of traders? Or are you rather the type of car driver who prefers to be on the safe side and drive at a leisurely speed, reaching his destination just the same? Taking breaks in between and rather going a bit too slowly than carelessly skidding off the road with your kids inside?

No matter if I trade or develop trading systems – the trick is

to not to rush anything rather than doing everything as fast as possible. I do not have to take care of ten trades every day to feel like a trader. Nor do I want to sit in front of my monitor all day long for fear of missing something. I am not Michael Schumacher who is still capable of thinking straight even when doing 120 miles an hour. I would rather look out of the window now and I am not obsessed with fi ve-minute charts; weekly charts can make you money as well without the hectic pace of high-speed trading. This reduces not only the amount of time that you are glued to the computer but also the risk of making a crucial mistake in the hustle and bustle of workaday life, ruining everything in the process. And alas, you cannot really help making very grave mistakes (in hindsight) now and then.

That is why a good car has an airbag, ABS, LGS, and everything else for that technology can provide. The good trader has a stop loss and knows when he loses control. When I see prices fl ashing in front of me all day and I could gamble away everything with only one mouse click, I need to do my trading in such a way that that very disaster is not going to happen. If I am inclined to feel like God Almighty after ten positive trades and to blow all my money with my eleventh trade, I need to adjust my position

sizing in such a way that that just cannot be done so easily.

There are speed limits and tons of prohibition signs on the roads, but in trading you often think the world could be reinvented every second. Accelerate when the roadway is wide and the next bend still far away. When I trade I sit in front of the screen and am full of concentration whenever daily and weekly charts point in the same direction. Then and only then is it time to pick up the pace a little. If the road is curvy, if it is uphill now and a little later downhill again, I will reduce speed when driving just as I slow down in trading, by reducing trading frequency. While I make less progress that way and my destination still seems far off, I won’t run the risk of hitting the next tree. And that is the best way to prepare for optimum performance again on the next straight and in the next clear trend. Trading is no competitive sport. Instead, trading is an activity that carries a lot of responsibility, and it is something you can make a living on. It can make you good money but only if you have a well-thought-out plan that you implement with discipline. Speedway races and Formula 1 parties are something else.

Chop-Chop!

Philipp Kahler

Mr Philipp Kahler is a trader,

developer of trading systems

and consultant who advises

institutional investors on

developing technical trading

strategies. In his book “Trading

Strategies (not) only for Extreme

Situations”, published in 2009,

he explains how steady yields

can be achieved by using

mechanical trading systems

and how these systems are

developed and tested. In

addition, he regularly publishes

articles on the subject of

Systems Trading in TRADERS’

magazine. You can reach Philipp

Kahler at [email protected].

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Interview: Thomas Stridsman – Money Management Is Keytradersonline-mag.com/01_ezine/01_traders/en/11/E_Tra12_web.pdf · TRADERS´ magazine. Further TRADERS´ editions will follow